Basic Assumptions and Concepts
Accounting is guided by several assumptions and concepts so that financial statements are prepared consistently and reliably.
- Going concern — the business is assumed to continue operating for the foreseeable future.
- Accrual — income and expenses are recorded when earned or incurred, not when cash is received or paid.
- Consistency — the same accounting methods are used from one period to the next so results can be compared.
- Prudence — do not overstate assets or income; record expected losses but do not record uncertain profits.
- Matching — expenses are matched with the income of the same period.
- Business entity — the business is kept separate from its owner.
Key idea
Accrual: income is recognised when earned and expenses when incurred — not according to cash flow.
Example
A shop sells goods on credit for RM3,000 in December but receives payment in January. Under the accrual basis, the RM3,000 sale is recorded in December, when the sale was earned.
Limitations of Accounting Information
Accounting has limitations: it records only items that can be measured in money (the money measurement concept), so non-financial factors such as staff morale or brand reputation are not recorded. It also uses estimates (for example depreciation) that may be inaccurate, and values based on historical cost may not reflect current market value.
Further Concepts
- Accounting period — business activity is divided into fixed periods, usually a year, so performance can be reported regularly.
- Materiality — only information important enough to affect decisions needs to be reported separately; small items may be combined.
- Historical cost — assets are recorded at their original purchase cost, not their current market value.
Remember
Accrual depends on when earned/incurred, not on cash flow. Prudence: do not overstate assets or profit.