1.5 Accounting Concepts and Conventions

In the beginning of this topic we noted that financial accounting is based on certain assumptions and principles which should be uniformly applied. They include; matching, monetary unit, going concern, time period, and separate entity concept.

Matching concept
We learnt that one of the uses of accounting information is to assess the performance of an organisation over a period of time. Decision makers will be interested in evaluating whether an entity generated resources that were more than what was consumed, commonly referred to as profits. This requires accountants to accumulate data regarding all resources that were generated (revenues). These are then compared with the amount of resources that were used up (expenses) in revenue generation. Comparison of revenues and expenses is one of the concepts of accounting referred to as matching.

Monetary unit
The common accounting practice is to attach value to effect of activities in an organisation commonly referred to as transactions. This requires that all transactions be accorded value in terms of the operating currency. The assumption is that a monetary value of all organisation's assets, liabilities and capital can be reliably determined.

Going concern
An accounting entity is assumed to have an indefinite life or closure of the entity is not foreseen when preparing financial accounts. Therefore, noncurrent assets are measured at their purchase costs with subsequent...

1.5 Accounting Concepts and Conventions

...adjustments made for wear and tear. We referred to this measurement basis as net realizable value. The assumption of business continuity in accounting is referred to as going concern concept.

Time period
As noted above, the business is assumed to have continuous operations for no anticipations for closure. However, there is need to review performance and position of an entity after a period of time, say a year. To make such an evaluation, it is assumed that the continuous life of a business can be split into a number of reporting periods of 12 months, financial year, for which financial reports can be produced.

Separate entity
The balance sheet equation discussed above is based on an assumption that the business and the investor are two parallel entities. Owners of an entity are not part and parcel of it. They simply have a claim on assets (capital) in the business. They are therefore assumed to transact with the business as third parties. This is the separate entity concept in accounting. It is useful in evaluation of the financial strength of an organisation independent of shareholders.