Slide 10.

Chapter 10
Accounting concepts and
assumptions

Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12th Edition, © Pearson Education Limited 2012
Slide 10.2

Learning objectives
After you have studied this chapter, you
should be able to:
 Describe the assumptions which are made
when recording accounting data
 Explain why one set of financial
statements has to serve many purposes
 Explain the implications of objectivity and
subjectivity in the context of accounting

Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12th Edition, © Pearson Education Limited 2012
Slide 10.3

Learning objectives (Continued)

 Explain what accounting standards are and why
they exist
 Explain the underlying concepts of accounting
 Explain how the concepts and assumptions of
materiality, going concern, comparability through
consistency, prudence, accruals, separate
determination, substance over form and other
concepts and assumptions affect the recording
and adjustment of accounting data and the
reporting of accounting information

Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12th Edition, © Pearson Education Limited 2012
Slide 10.4

Objective of financial statements

 Financial statements should provide
information about the financial position,
performance and changes in the finances
of an entity.
 Financial statements should be useful to a
wide range of users in making economic
decisions.
 Financial statements are prepared on the
basis of established concepts and must
adhere to the rules and procedures set
down in regulations, called accounting
standards.
Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12th Edition, © Pearson Education Limited 2012
Slide 10.5

Objectivity
 Financialaccounting seeks objectivity and
consistency in the preparation and
presentation of information.
 To achieve objectivity, a set of fundamental
rules have been devised, laying down the
way transactions are recorded.
 These rules are known as accounting
concepts and are enforced by their
incorporation in accounting standards
issued.
Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12th Edition, © Pearson Education Limited 2012
Slide 10.6

Concepts – Historical cost

 The historical cost concept requires that

assets are normally shown at cost price.

 Cost price is the basis for valuation of the

assets.

Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12th Edition, © Pearson Education Limited 2012
Slide 10.7

Concepts – Money measurement

The money measurement concept

requires that accounting information is
traditionally only concerned with facts that:

(a) Can be measured in monetary units.

(b) Most people will agree to the monetary
value of the transaction.

Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12th Edition, © Pearson Education Limited 2012
Slide 10.8

Concepts – Business entity

 The business entity concept implied that
the affairs of a business are to be treated
as being quite separate from the non-
business activities of its owner(s).
 Therefore, items recorded in the books of
the business are restricted to the
transactions of the business.

Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12th Edition, © Pearson Education Limited 2012
Slide 10.9

Concepts – Dual aspect

 The dual aspect concept states that there
are two aspects of accounting – one
represented by the assets of the business
and the other by the claims against them.
 This concept can be summarised by a
form of the accounting equation:

Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12th Edition, © Pearson Education Limited 2012
Slide 10.10

Concepts – Time interval

 The time interval concept requires that an

entity will prepare financial statements at
regular intervals during the year.

Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12th Edition, © Pearson Education Limited 2012
Slide 10.11

Concepts – Accruals
 The accruals concept states that the
effects of transaction and other events are
recognised when they occur and they are
recorded in the books and reported in the
financial statements of the period to which
they relate.
 This allows income and charges relating to
the period to be taken into account by
matching the income with the expenditure.
Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12th Edition, © Pearson Education Limited 2012
Slide 10.12

Concepts – Going concern

 The going concern concept assumes that
the business will continue to operate for at
least 12 months after the end of the
reporting period.
 This concept should only be ignored if the
business is going to close down in the
near future, or if a shortage of cash makes
it likely that the business will cease
trading.

Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12th Edition, © Pearson Education Limited 2012
Slide 10.13

Qualitative characteristics
of financial statements
There are four principal qualitative
characteristics:

 Understandability
 Relevance
 Reliability
 Comparability

Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12th Edition, © Pearson Education Limited 2012
Slide 10.14

The quality of understandability

Information in financial statements

should be readily understandable by users.

Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12th Edition, © Pearson Education Limited 2012
Slide 10.15

The quality of relevance

 Information in financial statements must
be relevant to users and influence their
economic decisions
 That which is material is relevant and
should be included. Information is material
if its omission or misstatement could
influence the economic decisions of users

Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12th Edition, © Pearson Education Limited 2012
Slide 10.16

The quality of reliability

The information in the financial statements must
be reliable – free from error and bias, and able to
be depended upon:
 It must be a faithful representation of transactions.
 Transactions must be accounted for and
presented in accordance with their substance, not
their legal form.
 Information must be free from bias.
 A degree of caution should be exercised when
making estimates.
 The information must be complete.
Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12th Edition, © Pearson Education Limited 2012
Slide 10.17

The quality of comparability

 The measurement and display of the financial
effect of similar transactions and other events
must be done in a consistent way throughout
an entity and over time for that entity, and in a
consistent way for different entities.
 Users must be informed of accounting policies
used and any changes.
 Financial statements must include
corresponding information for preceding
periods.
Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12th Edition, © Pearson Education Limited 2012
Slide 10.18

Constraints on relevant
and reliable information
 Information must be reported in a timely
manner.
 The benefits of information should exceed
the costs of obtaining it.
 The aim should be to achieve a balance
among the characteristics that best meets
the objective of financial statements.

Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12th Edition, © Pearson Education Limited 2012
Slide 10.19

Learning outcomes
You should have now learnt:

1. Why one set of financial statements has to

serve many purposes
2. Why the need for general agreement has
given rise to the concepts and conventions
that govern accounting
3. The implications of objectivity and
subjectivity in the context of accounting
Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12th Edition, © Pearson Education Limited 2012
Slide 10.20

Learning outcomes (Continued)

4. What accounting standards are and why

they exist
5. The assumptions which are made when
recording accounting data
6. The underlying concepts of accounting

Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12th Edition, © Pearson Education Limited 2012
Slide 10.21

Learning outcomes (Continued)

7. How the concepts and assumptions of
materiality, going concern, comparability through
consistency, prudence, accruals, separate
determination, substance over form, and other
concepts and assumptions affect the recording
and adjustment of accounting data and the
reporting of accounting information
8. That an assumption is made that monetary
measures remain stable, that is that accounts are
not normally adjusted for inflation or deflation

Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12th Edition, © Pearson Education Limited 2012