Understanding Bookkeeping

As bookkeepers, we need to at least understand the following:

ACCOUNTING ASSUMPTIONS:

• Economic Entity concept:- also known as Separate Business Entity Principle where a business is accounted SEPARATELY from other business entities, including its owner. The business records should be separated and distinct from personal records of business owner.
• For example, Mr A is the owner of a limited company XYZ Co. Mr X owned many personal assets like bungalows, exotic cars,etc. Assuming the limited company XYZ Co is being liquidated by the creditors, the personal assets of Mr X will not be touched by the creditors. Due to this business entity principle/concept, only the company is being affected.

• Monetary Unit concept:- transactions and events can only be expressed in monetary or money, units for example in USD or other currencies.
• Due to this monetary unit concept, annual reports has it limitation of not able to express events like appointment of CEO or other top management in quantifable terms like in USD currency,etc. Other examples like the factory productivity,etc

• Going Concern concept:-the business is assumed to continue operating instead of being closed/liquidated or sold or we can say that the business will continue its operation to the foreseeable future.
• Using this concept, ironically at times that we can see some ailing or unhealthy companies which show visible signs of deteriorating financial health but auditors or accountants still hold on to this going concern viewpoint.

• Time Period:-a business operation can be divided into specific period of time such as a month, a quarter or a year (accounting period).
• This time period concept/principle enables the financial statements to be reported timely and systematically as both internal and external users will know when to expect the financial statements.
• Also using this time period concept/principle, the accountant and other users can compare like-to-like over the same period of time say comparing Q2′ 2006 results with Q2′2007 results,etc.

ACCOUNTING PRINCIPLES/CONCEPT:

• Historical cost principle/concept:basically business should report its activities or economic events at their actual cost.
• For example, Company A has a piece of property bought twenty years ago which cost only $100,000. But the property’s present value is worth say $100 million but due to this historical cost principle/concept, the Company A can only record the historical actual cost of $100,000 into the company’s book.

• Revenue Recognition principle/concept: recognize revenue when it is earned, not too early and not too late.
• Hence, based on this revenue recognition concept, company record the revenue services/products is actually received by the customers and not when cash is only received.

• Matching or Accrual principle/concept: expenses are matched against revenues and recorded in the same period which revenue are earned.
• This matching principle/concept is so crucial as the company’s profit is recognized by matcing the income of the period with all the expenses incurred in earning such income.
• Imagine that this matching or the accrual concept is not followed- profits of companies will be reported irresponsibly resulting in the public investors buying their shares due to wrong perception of the company’s profitability!

• Full disclosure principle/concept: enough information must be reported to help users make knowledgeable decisions.
• Under this full disclosure principle, the financial statements should provide sufficient/relevant information to influence users’ decision making
• Let’s say a UK public listed conglomerate which own substantial properties in Argentina did not report truthfully and accurately the financial impact(s) of a major earthquake which destroyed a substantial part of the company’s assets. This can actually tantamount to fraudulent intention to cheat their shareholders!

CONSTRAINTS:

• Conservatism or Prudent Concept: requires that income and assets be recorded at the lowest reasonable amount
• This prudent or conservatism concept or principle assist to guide all financial expertise whether accountants/controllers/bookkeepers to choose option that minimize the possibilityof overstating an asset or income.

• Materiality Concept: significant items must be accurately measured.
• When we apply this materiality concept/principle, we must bear in mind the size of the company operation versus the items that we want to record in the books of account. Say the company is a billion dollar operation, stationery costing $500 or less obviously will not be significant.
• However, also imagine a company which is supposed to report a small profit of $15,000 before tax but has omitted to take up certain expenses amounting to $35,000- this is deemed material as this will change the profit into a loss situation.

This entry was posted on Wednesday, October 31st, 2007 at 5:36 am and is filed under a. Accounting Principles. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.