Chapter 9 - Accounting principles and concepts


Limited companies must prepare their financial statements within a framework which consists of general rules, regulations, principle and practices, governing the accounting treatment of financial transactions. The international accounting standards (IAS) are different codes of practice for limited companies which have evolved over time. An accounting standard is a statement on how certain types of transactions and other events should be reflected in financial statements in order that the statements give a true and fair view. The standards, together with the Companies Acts, set the parameters used by accountants in the preparation of financial statements. The aim is to make it easier to compare businesses around the world, increase transparency and trust in financial reporting, and foster global trade and investment.

Benefits of using IAS

  1. Provide guidance on preparing financial statements.
  2. Ensure consistency in treatment of transaction.
  3. Tend to globalise and harmonise the way financial statements are prepared.
  4. Restrict the opportunity for creative accounting (window dressing).

Accounting concepts, principles and conventions have been specifically designed to put into practice the different accounting standards. Accounting concepts and conventions are set of guidelines and procedures for preparing financial statements and aim to improve the true and fair view of financial statements. The main accounting concepts and conventions are:

Matching concept

Matching ensures that all income and expenditure are recognised in the financial period in which they occur. The timing of payment is irrelevant, i.e. if goods are sold in year one but not paid for until year two, then the sale is recognised in year one. Matching concept implies that all incomes accounted for when they are earned and expenditures are recognised when they are incurred. Expenses accrued are added and prepayments deducted when preparing financial statement.

Materiality Concept

Materiality allows that if the amount of a transaction is insignificant then the accepted treatment of that transaction may be disregarded. For example, the purchase of a stapler, which may last for several years, would tend to be treated as revenue rather than capital expenditure, and the stapler itself would not be included in non-current assets. Materiality concept allows disregarding the accepted accounting treatment of an item which has insignificant amount.

Business entity

This concept assumes that, for accounting purposes, the business enterprise and its owners are two separate independent entities. The financial statements of a business should provide information about the business only and should not provide information about the owner’s private financial affairs. For example, when the owner invests money in the business, it is recorded as liability of the business to the owner. Similarly, when the owner takes away from the business cash/goods for his/her personal use, it is not treated as business expense.

Money measurement

This convention states that financial accounting is concerned only with items which can be expressed in monetary terms. The main effect of this convention is that business assets to which a monetary value cannot reasonably be attributed (e.g. the skill of the workforce) are normally ignored in the financial statements, even though those assets might be great worth to the business concerned.

Going concern

The going concern concept states that a business will continue to operate for the foreseeable future. The financial statements are drawn up on the assumption that there is no intention to liquidate or curtail significantly the scale of operation. If a business is a going concern, some of its assets may have useful lives stretching into future years and the going concern concept allows the treatment of those assets in the financial statements to take into account the length of their useful lives.

Prudence concept

The concept states that an accountant should provide for all possible losses as soon as they are known to exist even though the amount at which they will materialise is uncertain. On the other hand, revenues and profits are not to be anticipated but are taken into account only when they are realised. In simple words, the accounts of a business should anticipate for probable losses and not profit. The application of a provision for doubtful debts is an example of the prudence concept.

Consistency concept

There are many different ways in which items may be treated in the accounts. Each company should select the most suitable methods which will give a fair picture of the activities of the business. Once a suitable method is selected for an accounting treatment, the same method is used in every accounting period.  Transactions of a similar nature should always be recorded in the same way. This is to ensure that the financial statements can be meaningfully compared each year. For example once a company uses the straight line method of depreciation for an asset, the same method should be used each year.

Historical cost concept

The historic cost convention states that assets should be shown in the statement of financial position at their original cost. The current market value of assets is ignored. The historical cost concept states that all assets are recorded in the books of accounts at their purchase price, which includes cost of acquisition, transportation and installation and not at its market price. The main advantage of this convention is that the historic cost of an asset is a fact, whilst any other valuation is only an estimate or an opinion.

Dual aspect concept

Dual aspect concept is the foundation or basic principle of accounting. It provides the very basis of recording business transactions in the books of accounts. This concept assumes that every transaction has a dual effect, i.e. it affects two accounts in their respective opposite sides. Therefore, each debit entry must have a corresponding credit entry. The duality concept is commonly expressed in terms of fundamental accounting equation: Assets = Liabilities + Capital

Realisation concept

This concept states that revenue from any business transaction should be included in the accounting records only when it is realised. The term realisation means creation of legal right to receive money. Selling goods is realisation but a transaction is not realised when an order is received. For example, a sale is considered to be realised when the customer takes ownership of the goods and not when money has been received.