Nowadays, accounting can be considered as an essential part of the business world, as it standardises financial reporting and proposes universal measures. In this instance, an accounting concept can be described as a basic set of ideas that are used to guide the science of accounting (Knowledge flow 2014). It is highly important since it defines the general framework for financial reporting while depicting the main regulations that have to be followed.
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It assists in avoiding confusion in accounting while making reporting concise, well-established, internationally understandable, and easy to interpret. Consequently, the primary goal of this paper is to explain the key accounting concepts in detail and provide different examples to enhance the understanding of these ideas. In the end, conclusions are drawn to summarise the main findings of the paper.
The Historical Cost Concept
To establish a foundation for discussion, the historical cost concept implies that the companies have to state in their balance sheets the monetary value of the asset at the moment of purchase or acquisition (Cunningham et al. 2014). It is evident that the economic environment tends to fluctuate. For example, an upward or downward shift is one of the factors that can affect the original price of the asset.
Thus, according to the historical cost concept, reporting the changes will create confusion, and it is a primary reason for not displaying these aspects in financial statements. For example, the enterprise purchased 1000 units for the price of $5. However, the price experienced changes, and now, it is $6 per unit. Nonetheless, the inventory will still be reported as $5,000 and not $6,000 since the principle of historical cost applies.
The Money Measurement Concept
Another essential accounting principle is the money measurement concept, and it is self-explanatory. This idea implies that only values of assets and liabilities that can be recorded in monetary terms are displayed in the financial statements (Knowledge flow 2014). It is highly linked to the reliability of the data, as reporting irrelevant financial values will cause confusion and inadequate reporting that can lead to fraud and violation of accounting standards. For example, it is evident that expenses associated with employees have clear monetary value and are often reported as costs for payroll and salaries. On the contrary, competences and know-how are often referred to as the most important assets of the company, but they cannot be evaluated in the monetary term, so they should not appear in financial statements.
The Business Entity Concept
The business entity principle is also of paramount importance, as it states that the transactions and operations of one company have to be separately recorded from other enterprises, organisations, and owners (Kolitz 2016). Following the ideas of this concept is crucial since it assists in making transactions transparent while easing taxation. For instance, the owner (co-founder of the business) gives his company a loan of $50,000. Apart from the fact that the financial resources are offered by the owner, this amount will be reflected as a liability. This example shows a clear application of this concept and ensures that the accounting records of different entities are not mixed.
The Dual Aspect Concept
To ensure the sufficiency of transactions and their reliability, it is critical to apply the ideas of the dual aspect concept. In this case, any financial transaction has to be reflected in at least two financial statements simultaneously (Knowledge flow 2014). It could be said that the idea of this principle pertains to the key accounting formula: Assets = Liabilities + Shareholder’s Equity. Keeping both sides in balance implies that some of the transactions have to be recorded twice to reach the equilibrium. For example, the owner of the company invested $50,000 in his/her business. This sum of money will appear in assets, but at the same time, it will result in an increase in shareholder’s equity by $50,000 and has to be also reported under this section.
The Time Interval Concept
In turn, one cannot underrate a critical role in the time period concept in making the accounting reporting concise and relevant. The idea states that the financial reports have to be divided into equal time intervals such as quarters (Kolitz 2016). Using this principle is vital for the financial viability of the company since applying it not only systemises the accounting reports but also helps monitor any financial changes and make appropriate future projections. For example, the companies tend to reflect changes in their financial positions every day, but the accounting period closes at the end of the month.
The Prudence Concept
For the efficient accounting practices, it is necessary to register expenses as soon as possible in the financial statements while the revenues have to be recorded after being realised, and this idea is reflecting in the prudence principle (Knowledge flow 2014).
It is evident that this concept ensures that the revenues are not overestimated, and costs are recorded promptly (Knowledge flow 2014). It assists the enterprise in having a realistic understanding of its finances and mitigating risks associated with bankruptcy. For example, the company paid $30,000 and $50,000 for rent and machinery respectively. Simultaneously, it gained $400,000 in revenues. In this case, it will record expenses first and then report profits.
The Materiality Concept
In addition, it is widely known that financial statements provide important information covering the company’s viability and financial health. In this case, to ensure its relevant interpretation, the materiality principle requires reporting all financial events and transactions that may affect the opinions of investors in any way (Cunningham et al. 2014). In turn, it is apparent that it is not rational to report any insignificant aspects, as they have no influence on the overall performance and financial stability of the organisation.
For example, the company’s factory was destroyed by the earthquake, and the expenses for restoration accounted for $20,000. Its net income was $80,000. In this case, these expenses have to be viewed as a material since $20,000 is 25% of the company’s income, and the investors have to know about it.
The Accruals Concept
Apart from being discussed at the end of the essay, the accruals principle can be regarded as fundamentals of accounting. It implies reflecting revenues and expenses in the period they take place (Ising 2013). Nowadays, many companies operate on credit, and waiting for the cash transaction and recording it after receiving an invoice could be considered as irrational. It will create difficulties when evaluating the financial performance of the firm.
After receiving cash, the organisation reverses the recorded statements and registers cash transfers and transactions. For example, the marketing agency tends to bill its clients monthly, but before that, it performs different services associated with customers’ projects. At the end of the month, it modifies the entries of accrued revenues (on credit). After sending the invoices, it changes these aspects again. In this instance, the expenses correspond to the revenues from the projects and vice versa.
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The Going Concern Concept
Lastly, the going concern principle implies that the company will aim at contingency and have enough financial resources to continue its operations in the recent future (Knowledge flow 2014). It could be said that the ideas of amortisation and depreciation suggest that the firm will be financially viable in the long-term, as, otherwise, it will not be able to pay back its liabilities and debts (Knowledge flow 2014).
It is evident that this concept contributes to the development of well-evaluated managerial decisions and future-oriented goals. For example, the international company violated the import regulations and transported some raw materials illegally. The firm lost $100,000 in its inventory and had to pay fines. Nevertheless, due to its international focus and outstanding financial performance, the company can be regarded as a going concern, as these negative consequences will not disrupt its operations.
In the end, it could be said that the essay unveiled the most important insights concerning the significance of accounting concepts and principles. It is apparent that they are employed to provide a universal framework for financial reporting, as, otherwise, it will create confusion. Simultaneously, they help register expenses and revenues in a timely manner to provide a relevant image of the company’s financial health to investors.
Apart from guiding functioning, accounting concepts shape a long-term orientation and imply that the enterprise will continue its operations by making well-evaluated decisions. Overall, it could be said that accounting principles are pivotal since they not only create a framework for reporting but also target at promoting continuity, innovation, effective budgeting, and development.
Cunningham, B., Nikolai, L, Bazley, J, Kavanagh, M, Slaughter, G & Simmons, S 2014, Accounting: information for business decisions, Cengage Learning, Melbourne.
Ising, P 2013, Earnings accruals and real activities management around initial public offerings: evidence from specific industries, Springer Science+Business Media, Berlin.
Knowledge flow 2014, Learn accounting, Knowledge flow, New York.
Kolitz, D 2016, Financial accounting: a concepts-based introduction, Routledge, London.