Dr Hafizah

Oct 2015

Short notes on accounting principles

Accounting principles are essentially general guidelines that you should follow when recording and
reporting accounting transactions. These principles are:
1.

Conservatism principle. You should recognize expenses and liabilities as soon as possible, even if
there is some uncertainty about them, whereas you should delay the recognition
of revenues and assets until you are certain of them. This tends to yield more conservative
reporting of profits and losses.

2. Consistency principle. Once you follow an accounting principle or method, you should continue to
do so in the future. This gives you more consistent reported results.
3. Cost principle. You should only record a transaction at its original acquisition cost. This principle
is less relevant as the accounting standards are pushing more in the direction of fair value.
4. Economic entity principle . You should keep separate the transactions of different business
entities. This prevents the financial results of multiple entities from becoming entangled.
5. Full disclosure principle . You should include in the financial statements of an entity all of the
information that might affect a reader's understanding of those statements. This has led to
the creation of a considerable amount of footnote disclosure that accompanies many financial
statements.
6. Going concern principle. This is the assumption that an entity will remain in business. This
assumption allows you to defer the recognition of some expenses to later periods (such
as depreciation), when a business will presumably still be in operation.
7. Matching principle. You should record all expenses related to a revenue-generating transaction
at the same time that you recognize the revenue. This is the foundation for the use of accrual
accounting.
8. Materiality principle. You should include all transactions in the financial statements if their
omission would otherwise influence the decisions of a person using the financial statements.
9. Monetary unit principle. You can only record an accounting transaction for something that can
be expressed in a currency. Thus, you cannot record the value of your employees, or similar
internally-generated intangible assets.

Dr Hafizah

Oct 2015

10. Reliability principle. You should only record those transactions for which you can obtain
objective evidence (such as a supplier invoice). If there is no evidence of a transaction, you
would have a difficult time proving it to an outside auditor.
11. Revenue recognition principle. You should only recognize revenue when you have substantially
completed all revenue-generating activities associated with the revenue to be recognized.
12. Time period principle. You should always record the activities of an entity over a standard time
period, such as a month or a year.

Dr Hafizah

Oct 2015

Underlying accounting concepts

i.
The historical cost concept
The need for this has already been described in the textbook valuation example. It means that
assets are normally shown at cost price, and that this is the basis for valuation of the asset.
ii.
The money measurement concept
Accounting information has traditionally been concerned only with those facts covered by ( a) and
(b) which follow:
(a) it can be measured in monetary units, and
(b) most people will agree to the monetary value of the transaction.
This limitation is referred to as the money measurement concept, and it means that accounting can
never tell you everything about a business. For example, accounting does not show the following:
(c) whether the business has good or bad managers,
(d) whether there are serious problems with the workforce,
(e) whether a rival product is about to take away many of the best customers,
(f ) whether the government is about to pass a law which will cost the business a lot of extra
expense in future.
The reason that (c) to (f ) or similar items are not recorded is that it would be impossible to work
out a monetary value for them which most people would agree to.
Some people think that accounting and financial statements tell you everything you want to
know about a business. The above shows that this is not the case.
iii.
The business entity concept
The business entity concept implies that the affairs of a business are to be treated as being quite
separate from the non-business activities of its owner(s).
The items recorded in the books of the business are, therefore, restricted to the transactions of
the business. No matter what activities the proprietor(s) get up to outside the business, they are
completely disregarded in the books kept by the business.
The only time that the personal resources of the proprietor(s) affect the accounting records of a
business is when they introduce new capital into the business, or take drawings out of it.
iv.
The dual aspect concept
This states that there are two aspects of accounting, one represented by the assets of the
business and the other by the claims against them. The concept states that these two aspects are
always equal to each other. Double entry is the name given to the method of recording transactions
under the dual aspect concept.
v.
The time interval concept
One of the underlying principles of accounting, the time interval concept, is that financial
statements are prepared at regular intervals of one year. For internal management purposes they
may be prepared far more frequently, possibly on a monthly basis or even more frequently.

Dr Hafizah

Oct 2015

Review questions on accounting principles and concepts:

1.
2.
3.
4.

What is meant by the money measurement concept?

Explain the concept of prudence in relation to the recognition of profits and losses.
Explain the term materiality as it is used in accounting.
The historical cost convention looks backwards but the going concern convention looks forwards.
Required:
(a) Explain clearly what is meant by:
(i ) the historical cost convention;
(ii ) the going concern convention.
(b) Does traditional financial accounting, using the historical cost convention, make the going concern
convention unnecessary? Explain your answer fully.
(c) Which do you think a shareholder is likely to find more useful a report on the past or an estimate of the
future? Why?
(Association of Chartered Certified Accountants)

Dr Hafizah

Oct 2015

Short notes on accounting equations and double entry system

Assets =

Liabilities

Capital

(Debit)

(Credit)

(Credit)

(Left side)

Right side

(Right side)

Balance Sheet

Revenues > Expenses------------- Profit

Revenues< Expenses--------------Loss
(Credit)
(Debit)

Income Statement/ Trading, profits & losses

Sales (Credit)
Sales returns/ return inwards (Debit)

Purchases (Debit)
Purchase returns/ return outwards (Credit)

Carriage inwards/freight in/ carriage on purchases (Debit)

Opening stocks (Debit)

E.g.:
Assets
i.

ii.

Liabilities
i.

Current assets
- Stocks (Closing)
- Debtors/ Account receivables (minus PFBD)
- Cash in hands
- Cash in bank
- Prepaid expense
- Accrued revenue
Fixed assets
- Land & building
- Premises
- Patents & copyright
- Fixtures & fittings
- Furniture & equipment
- Machinery
- Motor vehicles (minus depreciation)
- Computer
- Investment
- Goodwill
Current liabilities
- Creditors/ account payables
- Suppliers
- Bank overdraft
- Prepaid revenues/unearned revenues
- Accrued expenses

Dr Hafizah
ii.

Oct 2015
All unpaid amounts

Long-term liabilities
- Loan from bank
- Mortgage loans
- Bond
- Debenture

Owners equity
- Capital
- Retained earnings (+ net profit); (minus net loss)
- Drawings (Debit)---- for cash @ goods
Revenues: Fees earned/received
- Commission received
- Rent received
- Service revenues
- Discount received
- Interest received
- Decrease in PFBD
Expenses
-

Depreciation
Rent & rates
Advertising expenses
Insurance expenses
Salaries & wages
Bad debts
Discount allowed
Administration expenses
Impairment losses
Finance costs
Interest on loans/interest paid
Traveling/ transportation expenses
Bills & utilities
General expenses
Office expenses
Repairs expenses
Fuel
Maintenance expenses
Carriage outwards/freight out
Bank charges
Increase in PFBD

Dr Hafizah

Oct 2015

Review questions on accounting equations:

1.

Complete the gaps in the following table:

a
b
c
d
e
2.
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.
m.
n.
o.
3.

Assets

Liabilities

Capital

12500
28000
16800
19600
?

1800
4900
?
?
6300

?
?
12500
16450
19200

Which of the items in the following list are liabilities and which of them are assets?
Loan to C Shirley
Computers
Bank overdraft
We owe a supplier for goods
Fixtures and fittings
Warehouse we own
Motor vehicles
Owing to bank
Premises
Cash in hand
Creditors for goods
Loan from D Jones
Stock of goods
Machinery
Debtors
Cross (x) which of the following are wrongly classified:

Assets

Liabilities

Loan from C Smith

Cash in hand
Machinery
Creditors
Premises
Motor vehicles

Stock of goods
Debtors
Money owing to bank
Building

4.

B Wise is setting up a new business. Before actually selling anything, he bought a van for 4,500, a market
stall for 2,000 and a stock of goods for 1,500. He did not pay in full for his stock of goods and still owes
1,000 in respect of them. He borrowed 5,000 from C Fox. After the events just described, and before
trading starts, he has 400 cash in hand and 1,100 cash at bank.
Calculate the amount of his capital.

5.

F Flint is starting a business. Before actually starting to sell anything, he bought fixtures for 1,200, a van
for 6,000 and a stock of goods for 2,800. Although he has paid in full for the fixtures and the van, he still
owes 1,600 for some of the goods. B Rub lent him 2,500. After the above, Flint has 200 in the business
bank account and 175 cash in hand. You are required to calculate his capital.

Dr Hafizah
6.

Oct 2015

Complete the columns to show the effects of the following transactions:

Assets

Effect upon
Liabilities

Capital

Effect upon
Liabilities

Capital

(a) We pay a creditor 70 in cash.

(b) Bought fixtures 200 paying by cheque.
(c) Bought goods on credit 275.
(d) The proprietor introduces another 500 cash into the firm.
(e) J Walker lends the firm 200 in cash.
(f ) A debtor pays us 50 by cheque.
(g) We return goods costing 60 to a supplier whose bill we had not paid.
(h) Bought additional shop premises paying 5,000 by cheque.

7.

Complete the columns to show the effects of the following transactions;

Assets

(a) Bought a van on credit 8,700.

(b) Repaid by cash a loan owed to F Duff 10,000.
(c) Bought goods for 1,400 paying by cheque.
(d) The owner puts further 4,000 cash into the business.
(e) A debtor returns to us 150 goods. We agree to make an allowance for them.
(f ) Bought goods on credit 760.
(g) The owner takes out 200 cash for his personal use
(h) We pay a creditor 1,150 by cheque.

Dr Hafizah

Oct 2015

Review questions on Double-entries:

1.

Complete the following transactions:

Account to Debited
(a) Bought office machinery on credit from D Isaacs Ltd.
(b) The proprietor paid a creditor, C Jones, from his private funds.
(c) A debtor, N Fox, paid us in cash.
(d) Repaid part of loan from P Exeter by cheque.
(e) Returned some of office machinery to D Isaacs Ltd.
(f ) A debtor, N Lyn, pays us by cheque.
(g) Bought van by cash.
2.

Complete the following table:

Account to Debited
(a) Bought lorry for cash.
(b) Paid creditor, T Lake, by cheque.
(c) Repaid P Logans loan by cash.
(d) Sold lorry for cash.
(e) Bought office machinery on credit from Ultra Ltd.
(f ) A debtor, A Hill, pays us by cash.
(g) A debtor, J Cross, pays us by cheque.
(h) Proprietor puts a further amount into the business by cheque.
(i) A loan of 200 in cash is received from L Lowe.
( j) Paid a creditor, D Lord, by cash.
3.
20X7
July

4.
20X8
June

Account to be credited

Account to be credited

Write up the asset and liability and capital accounts to record the following transactions in the records of F
Murray.
1 Started business with 15,000 in the bank.
2 Bought office furniture by cheque 1,200.
3 Bought machinery 1,400 on credit from Trees Ltd.
5 Bought a van paying by cheque 6,010.
8 Sold some of the office furniture not suitable for the business for 150 on credit to D Twig & Sons.
15 Paid the amount owing to Trees Ltd 1,400 by cheque.
23 Received the amount due from D Twig & Sons 150 in cash.
31 Bought more machinery by cheque 650.
You are required to open the asset and liability and capital accounts and record the following transactions
for June 20X8 in the records of P Bernard.
1 Started business with 12,000 in cash.
2 Paid 11,700 of the opening cash into a bank account for the business.
5 Bought office furniture on credit from Dream Ltd for 1,900.
8 Bought a van paying by cheque 5,250.
12 Bought equipment from Pearce & Sons on credit 2,300.
18 Returned faulty office furniture costing 120 to Dream Ltd.
25 Sold some of the equipment for 200 cash.
26 Paid amount owing to Dream Ltd 1,780 by cheque.
28 Took 130 out of the bank and added to cash.
30 F Brown lent us 4,000 giving us the money by cheque.

Dr Hafizah
5.
20X9
June

Oct 2015

Write up the asset, capital and liability accounts in the books of D Gough to record the following
transactions:
1 Started business with 16,000 in the bank.
2 Bought van paying by cheque 6,400.
5 Bought office fixtures 900 on credit from Old Ltd.
8 Bought van on credit from Carton Cars Ltd 7,100.
12 Took 180 out of the bank and put it into the cash till.
15 Bought office fixtures paying by cash 120.
19 Paid Carton Cars Ltd a cheque for 7,100.
21 A loan of 500 cash is received from B Berry.
25 Paid 400 of the cash in hand into the bank account.
30 Bought more office fixtures paying by cheque 480.

6. Write up the accounts to record the following transactions:

20X7
March 1 Started business with 750 cash and 9,000 in the bank.
2 Received a loan of 2,000 from B Blane by cheque.
3 Bought a computer for cash 600.
5 Bought display equipment on credit from Clearcount Ltd 420.
8 Took 200 out of the bank and put it in the cash till.
15 Repaid part of Blanes loan by cheque 500.
17 Paid amount owing to Clearcount Ltd 420 by cheque.
24 Repaid part of Blanes loan by cash 250.
31 Bought a printer on credit from F Jones for 200.

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