Accounting Concepts And

Conventions
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 Definitions
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Accounting concepts and conventions are the set of rules,

principles, postulates, conventions and methods applied in
the measuring and recording of business transactions and
reporting financial information.
Accounting bases are the methods used for applying
fundamental accounting concepts to financial transactions
and events when preparing and presenting financial
statements, e.g. method of depreciation.
Accounting policies are the accounting bases adopted and
consistently followed by an organization in the preparation
of financial statements, e.g. straight line method of
depreciation.

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 Usefulness of Accounting Concepts
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Standardization
Consistency
Comparability

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 Fundamental Accounting Concepts
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Going Concern
Prudence/ Conservatism
Accrual
Consistency

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 The Going Concern (Continuity) Concept

 The going concern concept assumes that an enterprise will continue

in operational existence for the foreseeable future or for an
indefinitely long period of time, and there is no intention to put the
company into liquidation or make a drastic cutbacks to the scale of
operations.

 The main significance of the GCC is that the assets of the business
should not be valued at their ‘break-up’ value, which is the amount
that they will sell for if they were sold off piecemeal and the business
were thus put to an end.

 This convention is seen as providing support for the historic cost

convention as its is argued that estimates of current value only
become relevant in the event that the business intends to cease
trading and sell its assets.
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 The Going Concern (Continuity) Concept
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 For example:
 Prepayments, depreciation provisions may be carried forward
in the expectation of proper matching against the revenues of
future periods
 Property Plant and Equipment are recorded at historical cost
and depreciated over its useful life

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 The Prudence (Conservatism) Concept
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This convention requires that losses, whether actual or

anticipated, should be recognized and accounted for
whereas profit should only the recognized when realized.
The concept supports the historic cost and realization
conventions and ensures that where alternative procedures
or valuations exist, the one selected should be that which
would tend to understate rather than overstate profit.
 Revenues and profits are not anticipated. Only realized profits with
reasonable certainty are recognized in the SPLOCI
 However, provision is made for all known expenses and losses
whether the amount is known for certain or just an estimation
 This treatment minimizes the reported profits and the valuation of
assets

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 The Prudence (Conservatism) Concept
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Example
 PPE values are at cost rather than current market value in the
Statement of Financial Position
 PPE must be depreciated over their useful economic lives
 Inventory valuation sticks to rule of the lower of cost and net
realizable value
 The provision for doubtful debts should be made
 Profit on unsold inventory is not anticipated and credit taken
of the desired profit in the current period but deferred to the
year of sales when the sales revenue will be realized

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 The Accrual Concept
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 Revenues are recognized when they are earned, but not when
cash is received
 Expenses are recognized as they are incurred, but not when cash
is paid
 The net income for the period is determined by subtracting
expenses incurred from revenues earned
Example
 Expenses incurred but not yet paid in current period should be
treated as accrual/accrued expenses under current liabilities
 Expenses incurred in the following period but paid for in advance
should be treated as prepayment expenses under current asset
 Depreciation should be charged as part of the cost of a PPE
consumed during the period of use

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 The Consistency Concept
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 Companies should choose the most suitable accounting

methods and treatments, and consistently apply them in every
period
 Similar transactions should be treated in a similar manner
during the accounting period
 The accounting policies for the treatment of items should be
consistent from period to period.
 Changes are permitted only when the new method is
considered better and can reflect the true and fair view of the
financial position of the company
 The change and its effect on profits should be disclosed in the
financial statements
 Consistency allows for a more valid and meaningful
comparison of figures to be made from one period to the next

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 The Consistency Concept
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Examples
 If a company adopts straight line method and should not be
changed to adopt reducing balance method in other period
 If a company adopts weight-average method as stock valuation
and should not be changed to other method e.g. first-in-first-
out method

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 Business Entity Concept
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The business and its owner(s) are two separate

existing entities
Any private and personal incomes and expenses of
the owner(s) should not be treated as the incomes
and expenses of the business
The investment in business by the owner is shown by
way of owner's capital or claim over business assets

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 Dual Aspect (Double Entry) Concept
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Each business transaction must have two effects

which are equal and opposite such that the account
equation will always hold.
Double entry is the name given to the method of
recording business transactions so that the dual
aspect concept is upheld
The golden rule of double entry book keeping is
stated thus, “for every credit there must be a
corresponding debit and vice versa”

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 Money Measurement Concept
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All transactions of the business are recorded in terms

of money
It provides a common unit of measurement
Examples
 Market conditions, technological changes and the efficiency of
management would not be disclosed in the accounts

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 Historical Cost Convention
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Assets should be shown on the balance sheet at the

cost of purchase instead of current value
This convention provides an objective, reliable base
for financial reporting

Example
 The cost of PPE is recorded at the date of acquisition cost. The
acquisition cost includes all expenditure made to prepare the
asset for its intended use. It includes the invoice price of the
assets, freight charges, insurance or installation costs

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 Materiality
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An item is described as material if its omission or

misstatement has the potential to influence economic
decision
Thus, immaterial item in a set of accounts is one too trivial
to affect the reader’s understanding and perception of the
accounts.
Materiality therefore is an issue not so much of size, but of
significance
Immaterial amounts may be aggregated with the amounts of
a similar nature or function and need not be presented
separately
Materiality depends on the size and nature of the item
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 Materiality
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Example
 Small payments such as postage, stationery and cleaning
expenses should not be disclosed separately. They should be
grouped together as sundry expenses
 The cost of small-valued assets such as pencil sharpeners and
paper clips should be written off to the profit and loss account
as revenue expenditures, although they can last for more than
one accounting period

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 Realization Concept
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The realization concept states that sales (or revenue)

are normally recognized when the goods being sold
passes to the customer, or the service is rendered,
and is accepted by the customer.
Therefore profit is normally recognized at the time
when the goods or services are passed to the
customer and he incurs liability for them rather than
at date of payment, or when the contract is signed
Revenues should be recognized when the major
economic activities have been completed
Sales are recognized when the goods are sold and
delivered to customers or services are rendered
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 Matching concept
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The matching convention asserts that expenses

should be matched to the revenues to which they
relate such that both the revenue and the associated
expenses incurred in earning the revenue are
recognized in the same accounting period.
An effect of the matching convention is that assets
stated in the Statement of financial position provide
details of unexpired costs to be allocated to future
accounting periods.

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 Objectivity
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Accounting statements should be based on facts, but

not opinion.
The accounting information should be free from bias
and capable of independent verification
The information should be based upon verifiable
evidence such as invoices or contracts

Example
 The recognition of revenue should be based on verifiable
evidence such as the delivery of goods or the issue of invoices

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