Basic Accounting Concepts Business Entity Concept/Ac counting Entity Concept According to this concept, the business is considered as a separate business entity from its owner(s). Thus the financial information of the business will be recorded and reported separately from its owner’s personal financial information. Going Concern For accounting purposes, it is assumed that the business will operate for an indefinite period of time and thus considered as ‘going concern’. For this reason, the realizable value of the property owned by business will not be relevant. Money Measurement Only those transactions will be recorded in the financial books which can be measured in terms of money. Anything which cannot be measured in monetary terms will not be considered as a part of the accounting data. Historical Cost All assets will be recorded at their cost price. This means that machinery purchased years ago will be recorded at its original cost of purchase even though its value is lower now. The reason for doing so is because the business is considered as a going concern and we need not be worried about the saleable value of the asset. Accountin g Period The life a business is considered to be indefinite. But for accounting purposes, the life of the business is divided into specified periods of time. The period may be a month, a half year, a full year or any length of time. Accrual Concept Accrual concept states that revenue is recognized when it is earned and expenses when they are incurred. Any income or revenue generated must be recorded in the books of accounts whether the payment for it is received or not. Similarly, a ny expense done by the business should be recorded irrespective of the fact that the business has paid for it or not. Objectivity Any transaction which is recorded in the accounting books should be verifiable. In other words, the transaction should backed by some proof in the form of a receipt, invoice, cheque, voucher etc. Consistency According to this concept, the same accounting method should be applied in each accounting period when preparing financial reports. This makes it easy to compare results of one period with another period and the stakeholders can get a more realistic idea about the performance of the business. Prudence It involves being cautious while reporting accounting information. The assets should not be overstated and the liabilities should not be understated. This is why closing stock is always valued at the lower of cost or market value so that the profits are not overstated.
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Minority balances in Control AcccountsNormally, debtors accounts have debit balances
Creditors accounts contain credit balances.
There may instances when debtors might return some goods after their accounts have been settled and this may lead
them to have a credit balance.
What to do? The Debtors control Account will have both the debit and credit balances brought down.
Same procedure will take place for Creditors Control Account.
Through this the true financial position is shown i.e. the exact amount owing by debtors as well as the amount owing
to them.
Trial BalanceTrial Balance is a statement prepared with the debit and credit balances of ledger accounts toverify the arithmetical accuracy of the book.
The Trial Balance checks the equality of debits and credits in the ledger by listing each account along with its ending
balance.
Accounts to be
placed on debit
side
Accounts to be
placed on credit
side
Assets
Expenses
Drawings
Liabilities
Capital
Revenue
Errors revealed by Trial Balance
Errors in calculation Any calculation mistake, especially totaling mistake or balancing mistake will be revealed by Trial Balance as both the
side will not match.
Errors of omission of one entryIf by mistake only one entry is made for a transaction, Trial Balance will not balance.
Assets Assets are items of value owned by the business. Examples include
Building
Machinery
Motor vehicle
Cash at bank
Cash in hand
Stock
Debtors (people who own money to the business)
LiabilitiesThese denote the amounts which the business owes to others. Examples include
Creditors (people to whom the business owes money)
Bills payable Bank overdraft
Bank loan
Owner’s equity The funds of a business provided for by its owners.
Owner’s equity = Assets – Liabilities
Owner’s equity increases by Owner’s equity decreases by
Profits Losses
Additional investment into the business Drawings
Double entry SystemLook at an example:
You own a business, for example, selling shoes.
When you buy shoes from manufacturer: Transaction is your stock increase because new stock comes in. You pay for that stock and thus your cash reduces.
What does it mean? Two entries
Stock increases
Cash decreases
This system is known as Double entry system of book-keeping because for every transaction there are two
entries.
In this system all transactions are entered in a set of accounts.
An account is a place where all the information referring to a particular asset or liability or to capital is
entered.
Thus there is an account for everything in the business e.g. machinery, furniture, creditors, debtors and even capital.
What is an AccountEach account is shown on a different page.