CHAPTER 2

ACCOUNTING CONCEPTS
AND CONVENTIONS
 LEARNING OBJECTIVES
After completing this chapter, you should be able to:
• Discuss the key accounting concepts and conventions
• Explain the key characteristics of accounting information
ACCOUNTING CONCEPTS AND CONVENTIONS
• are the basic standards or guidelines regarding the application
of accounting rules.
• to ensure that the business would have a standardised
methodology in preparing financial reports.
• promote comparisons of financial results from industry to
industry and from year to year.
• Act as a foundation for the preparation of the financial
statements of an enterprise.
 ACCOUNTING CONCEPTS AND CONVENTIONS

• Business entity • Neutrality

• Going concern • Materiality
• Monetary measurement • Consistency
• Accrual • Full Disclosure
• Comparability
 Business entity
• A business and its owner should be treated separately as far as
their financial transactions are concerned.
• This convention seeks to ensure that private transactions and
matters relating to the owners of a business are segregated
from transactions that relate to the business.
 Going concern
• In accounting, a business is expected to continue for a foreseeable
future. It is assumed that the business has neither the intention
nor the need, to liquidate or curtail materially the scale of its
operations.
• A bankrupt company or a business near bankruptcy is the opposite
of a going concern.
• This has important implications for the valuation of assets and
liabilities.
• The concept of depreciating and amortising assets is based on the
idea that businesses will continue to operate for a foreseeable
future.
 Monetary measurement
• Only business transactions that can be expressed in terms of
money are recorded in accounting, though records of other
types of transactions may be kept separately.
• Accountants do not account for items unless they can be
quantified in monetary terms.
• Items that are not accounted for (unless someone is prepared
to pay something for them) include things like workforce skill,
morale, market leadership, brand recognition, quality of
management etc.
 Accrual

• Accrual concept requires revenues to be recognised when they are

earned and not when they are received in cash.
• For expenses, the concept requires expenses to be recorded when
they are incurred and not when they are paid.
• From this concept, profit is recognised only when it is earned,
hence an advance or fee paid is not considered as revenue until the
goods or services have been delivered to the buyer. Specifically,
under accrual concept, the transaction is recognised at the point of
sale or transfer of legal ownership, even when the actual payment
may not arise until several weeks or months.
 Comparability
• Accounting information is comparable when accounting
standards and policies are applied consistently from one period
to another and from one region to another.
• The characteristic of comparability of financial statements is
important because it allows us to compare a set of financial
statements with those of prior periods and those of other
companies.
 Neutrality
• Under this concept, financial statements must be free from
bias or errors, either deliberately or systematically.
• Neutrality means the financial statements were prepared to
reflect a balanced view of the affairs of the business not with
any purpose to influence certain decisions.
• Deliberate bias is where management intentionally misstates
the financial statements, while systematic bias happened when
the accounting systems inherently developed a tendency of
favouring one outcome.
 Materiality
• In accounting, an item should be regarded as material if it would
influence the decision of an informed investor. The materiality of an
item depends on its amount and its nature.
• Since the preparation of accounts involves a high degree of
judgement, the concept of materiality is an important issue for
users of financial accounts. For example, purchase of items like
pen, stapler, punching machine etc., though can be treated as part
of assets considering their durability and span of life but it is not
practical to maintain separate ledgers. Under materiality
convention, such low-cost items can be treated as an expense for
the period.
 Consistency
• This convention plays a vital role when there are acceptable
alternative accounting practices. Rules and practices of accounting
should be treated the same way from year to year, or period to
period.
• This enables the users to draw conclusions and make more
meaningful comparisons of financial performance over a number of
years.
• The comparisons are possible only if a consistent policy of
accounting is followed. Hence when accounting policies are
changed, businesses are required to disclose this fact and explain
the impact of any change.
 Full Disclosure
• Under this convention, financial statements should report all
material and relevant facts of financial position and the results
of operations, which have material interests to the users of
financial statements such as proprietor, creditors and investors.
• This convention requires that financial statements should
disclose all material information in which the emphasis is only
on material information and not on immaterial information.
 QUALITATIVE CHARACTERISTICS OF ACCOUNTING
INFORMATION
Accounting information should satisfy the following criteria
• Understandability
• Relevance
• Consistency
• Comparability
• Reliability
 Understandability
• Understandability means the users of accounting information
are able to understand accounting information, given they
spend the necessary time.
• The users are generally assumed to have a reasonable
knowledge of business and economic activities.
 Relevance
• Relevance is where the information generated is useful, in
which accounting information should impact the decision
making of users using the information.
• The concept can involve the content of the information and/or
its timeliness, both of which can impact decision making.
 Consistency
• This quality implies that the same accounting treatment must
be applied at all times to a given type of accounting data.
• Without consistency, accounting information is not comparable
and would not be useful in decision making.
 Comparability
• Comparability means that users are able to compare similar
companies in the same industry group and to make
comparisons of performance over time.
• It is a subset of consistency, where comparison of accounting
data is only possible if the data is prepared using the same
methods or standards.
 Reliability
• Reliability implies that the accounting information that is
presented is truthful, accurate, neutral, complete and
verifiable.
• If accounting information is not reliable, then it cannot be used
to make good business decisions.
 SELF ASSESSMENT QUESTIONS
THEORY (QUESTION 2)
Identify the accounting concept that describes each situation
below:

a. At the end of the accounting period, the stationery worth

RM25 was counted as an expense rather than an asset.
THEORY (QUESTION 2)
b. Ali Baba Biz acquired a new computer which can be used for
10 years in the business. Depreciation is provided on a straight-
line basis as to be similar to other computer owned by the
business.
THEORY (QUESTION 2)
c. As an account clerk, Ms. Rose only records those transactions
that can be measured in monetary terms.
THEORY (QUESTION 2)
d. The owner of Tirai Seri Interior took RM1,000 worth of goods
for his family. For accounting purposes, the owner is always
considered to be separate and distinct from the business which
he owns.
 MULTIPLE CHOICE QUESTIONS
1. According to the accrual concept of accounting, financial or business
transaction is recorded ___________.
A. when cash is received or paid
B. when a transaction occurs
C. when the Statement of Financial Position is prepared
D. when profit is computed
 MULTIPLE CHOICE QUESTIONS
2. The FB Advert Excel provides advertising services to an investment company in the
year 2017 but received the payment in the year 2018. FB Advert Excel recognises this
revenue in the year 2017. This action of FB Advert Excel is justified by ___________.
A. the comparability concept
B. the accrual concept
C. the business entity concept
D. the going concern concept
 MULTIPLE CHOICE QUESTIONS
3. A business is a going concern if ___________.
A. its Statement of Financial Position shows a strong financial position
B. its Statement of Profit or Loss for the current year shows a huge profit
C. there is no evidence that it will or will have to cease operations within
the foreseeable future
D. it is company listed in Bursa Malaysia
 MULTIPLE CHOICE QUESTIONS
4. Which accounting concept or principle states that the transactions of a
business must be recorded separately from those of its owners or other
businesses?
A. Accrual concept
B. Going concern concept
C. Monetary measurement concept
D. Business entity concept
 MULTIPLE CHOICE QUESTIONS
5. Which of the following states that a transaction is not recorded in the
books of accounts unless it is measurable in terms of money?
A. Accrual concept
B. Going concern concept
C. Monetary measurement concept
D. Neutrality concept
 MULTIPLE CHOICE QUESTIONS
6. The revenue is not recognised until it is earned and realised or at least
realisable. To which accounting principle/concept this statement belongs?
A. Business entity concept
B. Accrual concept
C. Going concern concept
D. Monetary measurement concept
 MULTIPLE CHOICE QUESTIONS
7. The auditor noticed that the financial statements of Meta Company
were missing some important footnotes for users in making a decision.
This action of the management is a violation of ___________.
A. the materiality concept
B. the going concern concept
C. the business entity concept
D. the full disclosure concept
THE END