Chapter 14 Accounting Principles

CHAPTER 14
_______________________________________
ACCOUNTING PRINCIPLES
LEARNING OBJECTIVES
At completion of this chapter, you should be able to:
Distinguish between accounting principles, bases and policies
State and explain the accounting principles

14.1

INTRODUCTION

Accounting incorporates bookkeeping and the preparing of final accounts, and

all of these were covered in the earlier chapters. Students should realise by now
that the bookkeeping procedures follow a system called the double entry system.
As for the final accounts, certain guidelines must be followed before proper final
accounts can be produced. Thus, the need to follow accounting procedures and
principles is required so as to ensure objectivity and that everyone agrees to the
said treatment of information.
In Malaysia, the Malaysian Accounting Standards Board (MASB) was set up in
1997. Among the functions of the MASB is to issue new standards, review or
adopt existing accounting standards, issue statement of principles and to
develop a conceptual framework. To be in line with convergence programme of
International Accounting Standards Board (IASB), MASB is adopting the
standards issued by IASB. Thus, all standards issued by MASB are called
Financial Reporting Standards (FRS).
This chapter specifies the different procedures, guidelines, concepts and
conventions to be applied in accounting. These requirements are dealt with in
the Proposed Framework for the Preparation and Presentation of Financial
Statements issued by MASB.

14.2

ACCOUNTING CONVENTIONS, BASES AND POLICIES

Accounting principles or concepts refer to rules that must be followed to ensure

subjectivity. These concepts consist of conventions, bases and policy
considerations.

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Conventions are also called assumptions which refer to some kind of general
understanding or generally accepted idea. An example of a convention is the
economic entity principle.
Accounting base or basis is another important principle. It helps us further in the
recording process. It tells us how to measure, for example, expense or revenue
items. An example of an accounting basis is the accrual basis.
Finally, when it comes to policies, it deals basically with the adoption of a certain
accounting method or basis and the consistent application of that method or
basis. For example, in the case of depreciation, we have a choice on the use of
either the straight line or reducing balance method in the calculation of
depreciation. Once a particular method is chosen then this becomes the
companys policy.
At this initial stage, the students are not required to distinguish conventions from
bases and policies. All of them will be grouped into one heading, that is, as either
concepts or principles.

14.3

BASIC ACCOUNTING CONCEPTS

Economic Entity
This concept assumes that a business is separate and distinct from its owner
and from every other owner. Thus, the items recorded in business books are
limited to transactions affecting the business only. In other words, the records
and reports of a business should not include either the transactions or assets of
another business or the personal assets and transactions of its owner or owners.

Going Concern
This concept assumes that a business is a going concern that will continue to
operate in the foreseeable future, using its assets to carry on its operations, and
with the exception of merchandise, not offering the assets for sale. In other
words, the concept assumes that the business enterprise will have a long life,
and that it will last long enough to fulfil their objectives and commitments.

Monetary/Money Measurement
The assumption that the purchasing power of the unit of measure used in
accounting, the RM, does not change. This is done due to the following reasons:
a.
money is the common denominator
b.
monetary unit provides an appropriate basis for accounting measurement
and analysis
c.
monetary unit is the most effective means of expressing to interested
parties changes in capital, and exchanges of goods and services.

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Periodicity
The assumption implies that the economic activities of a business can be
divided into regular time periods, namely, monthly, quarterly or yearly. For
reporting purposes, financial statements are normally prepared on yearly basis.
However, for management purposes, they will be more frequently prepared
such as on quarterly or monthly basis.

Historical Cost
This concept requires that assets and services plus any resulting liabilities be
taken into the accounting records at cost. Cost is used since:
a.
it is definite and determinable
b.
accountants can provide objective and verifiable data in their reports
c.
costs are measured on a cash or cash equivalent basis.

Consistency
This concept deals with the consistent use of basis or methods. For example,
once a business has adopted the straight line method of calculating
depreciation, this method should be used both within one accounting period and
from one accounting period to another. This is because:
a.
general treatments of items does not differ from period to period
b.
to avoid misleading interpretation of accounting information, or
c.
erroneous comparisons of results of one period with those of another.

Accrual or Matching
Expenses for the accounting period incurred must be recorded irrespective of
whether they have been paid or not; similarly, revenues are brought to account
(earned) of the accounting period when they are earned irrespective of whether
money has been received or not. Following this, expenses incurred are then
matched with revenues earned that they help to generate. As a result, net
income is the difference between revenues earned and the expenses incurred in
earning the revenues.

Realisation
Profit is considered earned or realised at the time when goods or services are
passed to the customer and not when the order for the goods or services is
received; and the customer incurs liability for them.

Dual Aspect
Also called a dual or double entry concept since for every transaction two
aspects of accounting is involved, one represented by assets and the other by

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the claims against the assets. The accounting equation: Assets = Capital +
Liabilities, that has been covered earlier, clearly explains this concept.

Materiality
The recording of assets and liabilities does necessarily require a strict
adherence to any accounting principles if it is difficult or expensive as long as it
does not materially or significantly affect the reported net income of the
business. In other words, recording of trivial items in a special way is allowed. If
a transaction is considered to be material, it significantly affects the reported net
income of the business. Then it is recorded as a non-current asset. Otherwise, it
is treated as an expense.

Prudence
Businesses are surrounded with many uncertainties. If, because of the
uncertainties, it is difficult to record transactions one should record them in such
a manner that assets and income are not overstated, and expenses and losses
are not understated. Thus, any foreseeable losses should be recorded in the
current year whereas profit will be recorded when it is actually realized. An
example of the application of prudence concept is the calculation of provision for
doubtful debts.

GLOSSARY
Accrual/Matching

Expenses incurred during the accounting period will

be matched against revenue earned during the same
accounting period

Consistency

Once an accounting method is chosen, it should be

used both within one accounting period and from one
accounting period to another

Dual Concept

Every transaction has two aspects of accounting

Economic Entity

A business is separate and distinct from its owner and

from every other owner

Going Concern

A business will continue to operate in the foreseeable

future

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Historical Cost

Assets, services and any resulting liabilities will be

recorded at cost

Materiality

If a transaction is considered to be material, it

significantly affects the reported net income of the
business. Then it is recorded as a non-current asset.
Otherwise, it is treated as an expense

Monetary/Money
Measurement

The purchasing power of the unit of measure used in

accounting, the RM, does not change

Periodicity

The economic activities of a business can be divided

into regular time periods

Prudence

Any foreseeable losses should be recorded in the

current year, whereas profit will be recorded when it is
really realised

Realisation

Profit is considered to be realised at the time when

goods or services are passed to the customer

EXERCISES
1. State whether each of the following statements is True or False.
a.

The economic entity assumption states that economic events can

be identified with a particular unit or accountability.

b.

The monetary unit assumption states that transactions that can be

measured in terms of money should be recorded in the
accounting records.

c.

Continuity concept is an idea that a business is separate and

distinct from its owner or owners and from every other business.
(F)

d.

Cost principle - the accounting rule that requires assets and

services plus any resulting liabilities to be taken into the
accounting records at cost.

e.

Matching principle - the accounting rule requiring that wherever

possible the amounts used in recording transactions be based on
objective evidence rather than on subjective judgements.

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f.

Time period concept is the idea that the life of a business is

divisible into time periods of equal length.

2. Choose the best answer.

i.

The economic entity assumption states economic events

a.

of different entities can be combined if all the entities are

corporations

b.

must be reported to the Securities Commission

c.

of a sole proprietorship which cannot be distinguished

from the personal economic events of its owners

d.

can be identified with a particular unit of accountability

ii. Periodicity or time - period assumption implies that

a.

a business is separate and distinct from its owner or

owners and from every other business

b.

the purchasing power of the unit of measure used in

accounting, the RM, does not change

c.

the economic activities of an enterprise can be divided into

artificial time periods

iii. Which one is true regarding the concept of consistency?

a.

The accounting rule that requires assets and services plus

any resulting liabilities to be taken into the accounting
records at cost.

b.

The accounting rule requiring a persistent application of a

selected accounting method or procedure period after
period.

c.

Accounting rule requiring that whenever possible the

amounts used in recording transactions be based on
objective evidence rather than on subjective judgements.

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iv. For accounting purposes, the proprietor of an enterprise has always

considered to be separate and distinct from the business which he
controls or owns. In accounting term this is referred to as
a.
b.
c.
d.

Historical cost concept

Matching concept
Accounting Entity concept
Going concern concept

3. Fill in the blanks with the appropriate concept or principle.

a.

The recognition of revenues when earned and expenses incurred

regardless of when cash is received or paid. ________________

b.

When evaluating uncertainties, selecting the method of

measurement that yields the least favourable immediate result in
order to avoid self-serving exaggeration.___________

c.

An accounting concept that requires an entity to give the same

accounting treatment to similar events in successive accounting
periods. ___________

d.

For accounting purposes, the assumption made is that the

business will continue in operation indefinitely. _____________

e.

An accounting principle which indicates that an organisation is

viewed as a unit
independent from its owners. _____________

f.

An accounting concept that deals with significant information;

accordingly, insignificant items might be ignored in applying the
basic accounting concepts. ____________________________

g.

An accounting principle requiring costs necessary for the

generation of revenue are matched (offset) against the revenues
they helped to produce in the determination of periodic net
income. ___________________

h.

Accounting is only concerned with the recording of facts that can

be expressed in monetary terms, as opposed to using physical or
time units of measurement. ______________________

i.

An accounting principle requiring revenues to be recognised at

the time they are earned.___________________

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j.

4.

An accounting concept stating that the results of the operation of

a company are to be measured over specific intervals of
time._______________

Name the accounting concept referred to the following cases:

5.

i.

Financial statements are prepared with the expectation that a

business will operate indefinitely.

ii.

In the preparation of financial reports, the same accounting

method should be applied in each accounting period.

iii.

Revenue earned during an accounting period has to be matched

with expenses associated with earning that revenue.

Identify and state the relevant accounting concepts given, which is

suitable for each question below:
i.

RM Express Bhd. has traditionally depreciated its furniture and

equipment using straight line method. This year it has adopted the
reducing balance method without advising its shareholders about the
change. As a result, it is violating the _________________ concept.

ii.

Last year, a manufacturing company purchased a 3-storey

shophouse at a cost of RM 1 million. This year it is valued at RM2.5
million. However, the company continues to record in its books the
value of the shophouse at RM1 million. This is in line with the
_________________ concept.

iii.

A food-catering business has in recent years, experienced financial

problems in its business. It is in the stage of bankruptcy. However, it
has recorded all the accounts as though it is still in a good financial
position. This is not following the
______________________
concept.

iv.

Syarikat Melly Bhd. is a registered public company dealing with

housing development. The company took a bank loan worth RM5
million from Maybank repayable within 10 years. However, after a
period of 12 years this company fails to repay its loan. The bank has
decided to confiscate all the personal properties of the shareholders.
This is against the ____________________ concepts.

v.

A supermarket owner sells all kinds of groceries for its customers. It

records all the purchases and its sales in the accounting books in
terms of RM. This is in accordance with the _________________
concept.

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