Chapters
- 01. Entity Concept
- 02. Accruals Concept
- 03. Going Concern Concept
- 04. Conservatism Concept
- 05. Realisation Concept
- 06. Matching Concept
- 07. Materiality Concept
- 08. Consistency Concept
- 09. Dual-Aspect Concept
- 10. Cost Concept
"Accounting: Is possibly the most boring subject in the world. And also it could be the most confusing. But if you want to be rich, long term, it could be the most important subject." -Unknown
The Cambridge dictionary defines an accountant as someone who keeps or examines the records of money received, paid, and owed by a company or person. Due to this dry definition, television shows, movies and books accountants have been painted in a negative and lifeless way.
Many think that all accountants do is create invoices, determine tax incentives or analyze financial documents and for the vast majority of working professionals, this is a complete nightmare.
Nevertheless, accountants are highly skilled individuals who are regularly sought after for their services. Depending on their place of employment, their work is varied and anything from being dull.
During post-secondary accounting courses, aspiring accountants learn more about basic accounting concepts to become skilled at their craft.
Superprof is here to instruct all interested ones about the top ten key concepts of accounting.
Entity Concept
The entity concept is one of the most common concepts studied by accountants. It is a helpful concept that is practised to avoid confusion between the personal accounts of the business owner and their business.
In this financial situation, the accountant is cautious in separating the assets and liabilities that are devoted to business activities as entity assets and liabilities. The transactions and expenses of the business are to be set apart and reported rather than become the financial undertaking of the business' owner.
Without this concept, the records of various entities would be intermingled, and it would be tough to distinguish the taxable results of a single business.
There are a variety of business entities that can be observed such as sole proprietorships, partnerships, corporations and government entities.
The benefits of this concept benefit the business and business owners. Some of the most common advantages include the fact that each business entity is taxed separately, it is needed to determine the financial performance and prosperity of a single body and it is impossible to financially audit an entity if they have been combined with the finances of other individuals.
Accruals Concept
An accrual is a journal entry that can be used to recognise revenues and expenses that have been earned and spent. It is important to note that in this situation the related cash amounts that have been obtained or spent have not yet been received or paid out.
Auditors only accept financial statements that have been previously made using the accruals concept since statements made without using the accruals concept are considerably less accurate.
Besides, without accruals, the amount of revenue, expense, and profit or loss in a period will not correctly reflect the economic activity within a company. Click here to learn more about profit and loss accounting.
Since these different accounting concepts are a tad confusing to grasp here are a few examples of accruals that a business might record:
- Expense accrual for interest: essential for a borrower to register his interest expense before receiving the invoice and this is known as recording accrued interest,
- Expense accrual for wages: an employer can accrue all additional fees earned from the last couple of days from the month, and this is done to ensure that the full amount of wage payment is recognised,
- Expense accrual for supplier goods and services: crucial for estimating the number of expenses in the current month before even receiving the receipt from the supplier,
- Sales accrual: a company can accrue revenue for the amount of work completed to date, before also receiving the invoice or bill.
Going Concern Concept
The going concern concept is one of the fundamental concepts of accounting. Accountants using this concept assume that the company will stay in operation indefinitely and will stick to its current plans.
A benefit of this concept is that enterprises can spread the cost of an asset over its expected useful life, instead of accelerating the expense into the current period.
To do this, the accountant presumes that the enterprise will continue to meet its financial obligations by using its existing assets.
By using this concept, accountants do not envision a foreseeable halt of operations and liquidation of assets. Therefore, accountants possessing this belief, defer expenses to a later period when the business will still be in service and in better shape to handle added expenditures.
The going concern concept is not clearly defined when studying basic accounting principles. Hence, many accountants and companies are unsure when an entity should start to report this type of theory.
If a company is doubtful in continuing to use the going concern concept, an auditor may be asked to come in and analyse certain factors. Some of the factors that may be considered include negative trends in operating results, denial of trade credit to the company from its suppliers and legal proceedings against the company.
If there is a substantial issue, the auditor would mention it in his report along with some helpful suggestions about the company's well-being.
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Conservatism Concept
An essential accounting concept that is described as anticipating no profits and preparing or providing for all losses.
Accountants help businesses and individuals minimise their chances of maximum losses which are done by understating revenue and profits instead of overstating. This is especially true for expense amounts that have a certain degree of uncertainty.
This concept may seem bizarre, but it is done so that financial statements do not overstate the entity's financial position or prosperity.
Accounting firms or financial advisors who prefer to be cautious enjoy this concept and, besides, provide investors with accurate financial documents that are not exaggerated.
The conservatism method is arguably the most conservative of all accounting concepts. Profits and financial gains are not taken into consideration until they are realized, and the money is in the bank.
Realisation Concept
The realisation or recognition concept indicates the amount of revenue that should be recorded from a specific sale. The rules of the realisation method help the financial advisor determine that an income or expense has occurred.
This concept is realised when the seller receives the cash from the sale of goods or services. In this regard, it is very similar to the conservatism concept in that revenue or income is only recorded on financial documents when the money is received and not when the contract is written out.
In this accounting concept, accountants would recommend to clients that the income for a long-term project would not be paid in one lump sum but rather divided over time according to the work that has been done.
The most qualified accountants prevent major corporations from violating the realisation concept by accelerating the recognition of its revenue.
All of these concepts and more can be learned in accounting classes...
Matching Concept
This accounting concept is done to avoid overstatement of income in a period. The matching idea requires costs to be paired with revenue to prevent confusion when another financial expert is viewing the financial documents at a later time.
It is important to note, that to fulfil the characteristics of the matching concept correctly accountants need to have completed the realisation concept that was previously mentioned.
The costs and revenues need to be recorded in the same period such as a week, month, quarter or year to avoid deferring expenses into later period statements.
To fully understand this concept, we shall use an example. Let's say that your company bills £10,000 of services in a month, to report the income for that specific month accurately you must inform the expenses incurred while generating that income in the same month.
Balance sheets can be used by accounts to correctly use the matching concept and keep track of all costs and revenue for the business.
Materiality Concept
This accounting principle has accountants ignore insignificant expenses. However, it is important to mention that not just anything can be ignored. Only expenditures that have a small impact on the business' financial statements and will not mislead other financial advisors when reading them at a later time can be disregarded.
According to many accounting experts and laws, an accountant does not have to record any material or object that is considered immaterial.
The materiality concept also much depends on the sheer size of the entity. A multi-billion pound industry may consider £1 million pound transactions to be immaterial whereas some enterprises do not even earn more than £1 billion in annual revenue so this transaction would be regarded as very material.
Nevertheless, there are no clear instructions in deciding if an item is material or immaterial, so accountants need to exercise caution in this regard and record the details on the financial documents if they are not sure. It's better to be safe than sorry!
The most important thing to remember about this concept is that all transactions or expenses should be recorded if, in the long run, they will affect the company's financial results or cash flows. If these are not affected the expenses do not have not to be recorded.
To acquire further understanding of this crucial accounting concept, various articles available online to help inspiring accountants judge between material and immaterial objects or expenses.
Consistency Concept
Accountants work hard to help corporations, small businesses or enterprises choose an accounting method that best suits their needs. Once the entity has decided on the correct accounting concept, it must be consistent in using the same process to avoid financial complications.
If the entity refuses to take into consideration the invaluable advice of its accountant to avoid changing accounting methods, the comparison of financial statements from one period to another would be difficult and almost impossible.
Consistency is vital in a business setting to carefully record financial information and to help external sources understand the inner workings of a company.
Dual-Aspect Concept
This accounting method states that every single business transaction must be recorded in at least two different accounts. The dual-aspect concept has to do with double entry accounting and can be better understood using a financial equation:
Assets = Liabilities + Equity
The assets are what the company owns, the liabilities are what the entity owes to creditors, and the equity is the difference between the first two and represents what the company owes to investors.
This accounting concept that lies at the heart of the whole accounting process and the best accountants know that this equation must be visible on the balance sheet.
It is important to state that the total number of assets listed on the balance sheet must equal the total of all liabilities and equity.
Examples of this concept that can be commonly observed include issuing an invoice to a customer or receiving an invoice from a supplier.
Cost Concept
The cost principle requires accountants to record an asset, liability or equity at the original acquisition cost. One of the most common accounting method used to record transactions of newly acquired items.
However, it is important to note, a significant issue of the cost concept is the fact that the "worth" of assets change with time and when a company wants to liquidate, it is nearly impossible to record the market value for the assets of the entity at that moment in time.
Nevertheless, there still is hope, because the cost concept recognises that objects or assets depreciate. Hence, the depreciation amount is removed from the original cost to show the value as a net amount.
The cost concept cannot be used for financial investments and is the most effective when utilised to determine short-term assets and liabilities.
Accounting can be a vibrant academic discipline to study mainly due to its diversity of concepts and terms. Aspiring accountants will never bore if they develop their skills and keep up to date with the latest advancements and utilize small business accounting software to work in a more efficient manner.
If this article about key accounting concepts caught your attention, learn more about basic accounting terminology to pique your interest.
In addition, budding accountants need to learn more about double-entry bookkeeping and essential accounting principles.
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