Accounting Policies and Concepts: Guidelines

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Table of Contents

Introduction
Going concern concept
Accrual/Matching Concept
Example
Consistency
Entity concept
References

Introduction

The financial statements of entities are usually prepared and presented using the defined set of guidelines. These guidelines are accounting standards, concepts, and conventions. All these guidelines enhance the reliability of the financial statements.

Accounting concepts are the rules and procedures that are followed in the preparation and presentation of financial statements. There are several accounting concepts some of which include going concerned, matching (accruals) concept, consistency, materiality, and prudence concept (Williamson, D.1999)

Going concern concept

The ability of an entity to continue to exist into the foreseeable future depends on its financial position. Going concern concept assumes that the entity is not going to wound up shortly i.e. it will exist into the foreseeable future. This concept is therefore considered in the preparation of the balance sheet of an entity. The balance sheet of an entity shows the financial position and therefore the assets should not be disclosed at net realizable values but on net book values. Of course, some assets are presented in the balance sheet at their market values (Basic college Accounting 2008).

Any circumstances or uncertainties that are likely to affect the long-term existence of a company should be disclosed fully in the books so that the interested parties are informed on the ability of the company to continue operating. The accountants/auditors are therefore required by law to disclose the going concern situation of the entity.

An example that can illustrate the going concern concept is as follows; Company ABC has been making losses for the last 3 years. This has been largely due to the reducing market share caused by the entry of new rivals into the market. The company has not been able to meet its obligations due to a lack of funds and the management does not foresee any drastic change in the fortunes of the company.

Based on the information provided about the company, explain the long-term position of the company. ABC Company is insolvent because it is unable to pay off its debts. Therefore, there should be a disclosure in the financial statements that the going concern position of the company is in doubt (Tutor2u.2008).

Accrual/Matching Concept

In the generation of revenues, costs or expenditures are usually incurred. Therefore it is only necessary that these revenues be matched to the corresponding costs. Matching concepts recognize the need to ‘matching’ the revenues to the relevant costs in a particular period. This, therefore, means that only the incomes and costs of that particular period are recorded in the profit and loss.

Any prepaid income or expenses are usually eliminated from the profit and loss and disclosed as either an asset or liability in the balance sheet. If the resultant pre-paid incomes or expenditures do not meet the requirements of assets or liability, then, the items should not be recorded in the books (Bendery, Hussey and West. 2004. pg.37)

Example

If the company prepaid an expense e.g. rent, then, the pre-paid part of the expenditure is treated as an asset in the balance sheet under the correct assets.

In the accrual concept, all the accruals and pre-payments are used to adjust the respective accounts to arrive at the correct amount to be taken to the profit and loss in the current period. Another example is the cost of goods sold incurred in the generation of sales. The cost of sales is matched to the sales amount.

Consistency

The preparation and presentation of financial statements of an entity usually follow certain policies set by the management. Accounting policies are usually consistent with the accounting standards in use. Accounting policies are usually the principles, conventions, and rules that are applied in the preparation of financial statements. They are the guidelines used in the preparation and presentation of financial statements. It is a requirement that entities consistently apply these accounting policies each year to enhance the comparability of the financial statements. The consistency concept, therefore, calls for the application o the adopted policies consistently.

Any change in these accounting policies must be explained by the management in terms of how the change will improve on the usefulness, relevance, and reliability of the financial statements (Bendery, Hussey and West. 2004. pg.37)

An entity may, for example, decide to depreciate all its fixed assets using the straight-line method. Under the consistency concept, then, the entity should apply this policy always. Any change of policy should be clearly explained in the notes to the financial statements. Consistency policy ensures that the information presented in the financial statements can be used comparatively with those of other periods.

Entity concept

There are forms of business that make it hard to differentiate between the owner and the business in terms of assets or liabilities. An example is a sole proprietorship where the owner and the business are essentially one. The entity concept recognizes the fact that the business has a legal status as a person that is quite distinct from the owners. This in essence means that the transactions of the business are recorded separately in different accounts from the owners. The business is an entity that is quite separate and distinct from the owner. In the case of a sole proprietorship, items like drawings, for example, should be indicated clearly (Accounting web 2008).

References

Accounting web (2008). Accounting Concepts and Conventions. Web.

Bendrey, Mike, Hussey, Roger and West, Colston. Essential of Financial Accounting in Business. Accounting Concepts and Conventions. New York. Thomson Learning. 2004. Pg. 37-38.

Basic college Accounting (2008). Going concern Concept. Web.

Williamson, D. (1999). Accounting Concepts and Conventions. Web.

Tutor2u (2008). Accounting concepts and conventions. Web.

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