Accounting Concepts, Conventions and Solutions

Topics: Balance sheet, Generally Accepted Accounting Principles, Income statement Pages: 11 (3633 words) Published: March 30, 2013
Table of Contents
QUESTION ONE: Accounting Concepts and Conventions1
a)Accounting Concepts1
i)The going concern concept.1
ii)The accruals concept (or matching concept)1
iii)The entity concept:3
iv)The money measurement concept:3
v)The historical cost concept:4
vi)The realization concept:4
vii)Duality concept:4
b)Accounting conventions5
QUESTION TWO: Clashing accounting concepts and conventions that might bring about inconsistency in the accounting process9
1.Clash between the accruals/matching concept and the prudence convention9
2.Clash between the historical cost concept and Prudence convention9
QUESTION THREE: Solutions to the clashing accounting concepts and conventions11

QUESTION ONE: Accounting Concepts and Conventions
a) Accounting Concepts
Accounting Concepts are broad basic assumptions that underlie the periodic financial accounts of business enterprises. They outline the rules of accounting that should be followed in preparation of all financial statements. These concepts are outlined in the International Accounting Standard 1(IAS 1)-presentation of financial statements. The word ‘concept’ in this context means an idea or thought that has a universal application. This includes; i) The going concern concept: implies that the business will continue in operational existence for the foreseeable future, and that there is no intention to put the company into liquidation or to make drastic cutbacks to the scale of operations. Financial statements should be prepared under the going concern basis unless the entity is being (or is going to be) liquidated or if it has ceased (or is about to cease) trading. The directors of a company must also disclose any significant doubts about the company’s future if and when they arise.( Agatha,2010) The main significance of the going concern concept is that the assets of the business should not be valued at their ‘break-up’ value, which is the amount that they would sell for it they were sold off piecemeal and the business were thus broken up. ii) The accruals concept (or matching concept): states that revenue and costs must be recognized as they are earned or incurred, not as money is received or paid. They must be matched with one another so far as their relationship can be established or justifiably assumed, and dealt with in the profit and loss account of the period to which they relate. Example

Assume that a firm makes a profit of £100 by matching the revenue (£200) earned from the sale of 20 units against the cost (£100) of acquiring them. (Williamson,2001) If, however, the firm had only sold eighteen units, it would have been incorrect to charge profit and loss account with the cost of twenty units; there is still two units in stock. If the firm intends to sell them later, it is likely to make a profit on the sale. Therefore, only the purchase cost of eighteen units (£90) should be matched with the sales revenue, leaving a profit of £90.

The balance sheet would therefore look like this:
| £|
Assets| |
Stock (at cost, i.e. 2 x £5)| 10|
Debtors (18 x £10)| 180|
| 190|
Liabilities| |
Creditors| 100|
| 90|
Capital (profit for the period)| 90|

If, however the firm had decided to give up selling units, then the going concern concept would no longer apply and the value of the two units in the balance sheet would be a break-up valuation rather than cost. Similarly, if the two unsold units were now unlikely to be sold at more than their cost of £5 each (say, because of damage or a fall in demand) then they should be recorded on the balance sheet at their net realizable value (i.e. the likely eventual sales price less any expenses incurred to make them saleable, e.g. paint) rather than cost. This shows the application of the prudence concept. In this example, the concepts of going concern and matching are linked. Because the business is assumed...
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