accounting concepts, principles and policies
accounting concepts, principles and policiesThe concepts, principles and policies which must be followed in preparing accounting records and summarizing them in financial statements:
- the money measurement concept suggests that only items which can be measured in money terms will be shown in a company's accounts;
- the going concern concept suggests that all financial reports be prepared to reflect the business's expected continuation as a going concern which will trade in the future, rather than being a one-off venture or a business which is likely to cease trading imminently and have its assets sold off;
- the accruals concept suggests that all revenues and expenses should be taken into account when they become due rather than when they are actually received or paid. In this way revenues and profits are matched with the associated expenses incurred in earning them;
- the consistency concept suggests that all accounting information should be consistently based between one year and the next, to aid comparisons of performance over time. This means, for example, that a business should not readily switch from one DEPRECIATION method to another from year to year;
- the prudence or conservatism concept suggests that revenues and profits should never be anticipated in the accounts of a business, but should only be included in the PROFIT-AND-LOSS ACCOUNT when such revenues and profits are reasonably certain. This means, for example, that companies would take account only of sales made, not of orders taken, and even then might make provision for some customers who have bought goods not paying up. Companies would also take a fairly conservative view of the value of assets such as stock in following this principle, adjusting the book value of stocks down to their realizable market value when market values fall. The prudence principle aims to ensure that a business's profits and assets are not overstated nor its liabilities understated;
- the materiality concept suggests that only data which are significant enough to be relevant need be disclosed, minor items being ignored in accounting reports;
- the objectivity concept suggests a need to establish rules for recording and summarizing financial transactions which avoid the exercise of personal judgement by the person doing the recording and summarizing. Thus accountants usually account for ASSETS on the basis of their HISTORIC COST, since historic cost provides an objective basis, rather than estimating the changing market value of assets.
In preparing financial accounts for shareholders, joint-stock companies are required to disclose the specific accounting policies (based on the above principles) which they have used in valuing stocks, calculating depreciation and the like.