Compiled by Annie WPL

By Annie WPL

CHAPTER 2: FUNDAMENTAL ACCOUNTING CONCEPTS AND PRINCIPLES

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LEARNING OBJECTIVES
Understand 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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INTRODUCTION

Accounting 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 personal transactions of the proprietor. The personal assets of the owners or shareholders are not considered while recording and reporting the assets of the business 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 CONCEPT

A 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 to outsiders 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 its liquidation. Since life of business is assumed to be indefinite, the measurement of income according 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 MEASUREMENT CONCEPT

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 MEASUREMENT CONCEPT (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 MEASUREMENT CONCEPT (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 raw material and so on then in the absence of money measurement concept these different types of assets cannot be added to give useful information.

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MONETARY CONCEPT/MONEY MEASUREMENT CONCEPT (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 CONCEPT

Asset 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 CONCEPT
All 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 the formula 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 of accounts. Expenses are recognised at the time the services are received irrespective of when actual payment for the service is made.

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ACCOUNTING CONVENTIONS

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INTRODUCTION
Conventions 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 more useful.

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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 DISCLOSURE
All 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 MATERIALITY
Unimportant 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 the accounts, because it cannot possibly have any significant effect on the results. The materiality convention allows the other conventions to be ignored and a simpler accounting 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 of consistency. That is if one method of depreciation is followed it should be consistently followed for all the years. 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 with previous 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 following problems:
1. 2.

3.
4.

5.

Electricity consumed in 2009 and paid for in 2010. Equipment originally purchased for RM20,000, which would now cost RM30,000. A customer who might go bankrupt owing the company RM5,000. The proprietor who has supplied the business capital out of his own private bank account. Stock valuation method would be changed from AVCO to FIFO.

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