Accounting Principles | O Level Accounting 7707 & IGCSE Accounting 0452 | Detailed Free Notes To Score An A Star (A*)
- Matching
- Also called accrual principle
- Revenues that are generated in a period should be matched to the expenditure incurred during that period to generate revenue.
- Therefore, this principle considers that payment itself is not important: when payment for an expense was made is irrelevant.
- The main factor is when the benefit of that expense was used to generate revenue
- For example, if my business pays 100,000 for electricity, but it has only used 80,000 PKR worth of electricity in the current financial year, then only 80,000 should be recorded as the current expense. The rest is prepaid expense because the business has not yet used the benefit of that payment to generate revenue.
- On the other hand, if my business pays 100,000 for electricity, but it has already used the benefit of 200,000 worth of electricity during the current year. Therefore, 100,000 of the extra electricity that has been used but not paid for will become an accrued/ payable expense but the expense itself will be recorded during the same year.
- The same goes for income. If the business has generated 100,000 revenue this year, but 50,000 of this amount is UNPAID by customers, the 100,000 will still be recorded as the revenue for the current year. The unpaid amount will become accrued or receivable revenue.
- On the other hand, if a customer has paid 100,000, but has only received the benefit of the service equaling to 50,000 during the current year, then the other 50,000 will not be recorded as the revenue earned during the period. Instead, it will be considered uneaerned revenue.
- With this principle, we can determine the actual profit (even if its not paid up or paid to) for the period.
- Therefore, we need to match the expenses and profits to the period when they have been incurred, even if they have not been paid up in the same period.
- Business Entity
- Business is separate from the owners
- Business transactions must be separate from the owners, shareholders and any other business.
- Just like transactions of one human is different from the others.
- Therefore, if the owner withdraws from the business, it will be considered drawings.
- If more capital is introduced by the owner, it shall be recorded as owner’s equity.
- Personal expenses of the owner are not the same as business expenses.
- Business is separate from the owners
- Consistency
- There are different ways different things can be treated in accounting.
- For example, depreciation can be treated in multiple different ways: straight line, net book value etc.
- However, if the method if constantly changed, a falsely positive image of the business can be formed.
- Such actions are prevented by consistency principle.
- One method adopted must be used consistently.
- If changed, it must be publicly disclosed
- Using the same methods also allow for fair comparison over different periods
- There are different ways different things can be treated in accounting.
- Duality
- Every transaction has two sides – one debit side and the other credit side.
- Both sides must be equal
- Therefore, each transaction effects at least two items or accounts in a business.
- Going Concern
- It is assumed that once a business is started, it will continue indefinitely in the foreseeable future.
- Therefore, all short-term and long-term assets will be help by the business.
- The business will use its assets during the course of the business to pay its liabilities.
- However, where going concern isn’t applied, long-term assets are recorded at Net Realizable Value instead of cost.
- The going concern principle also means that we do not include naturally occurring goodwill into the books of the business.
- Only when a business is sold can this be included.
- Historic Cost
- Transactions, and assets, are recorded at their cost not direct net book value or current market value
- Therefore, asset T account is full of cost entries, not depreciation.
- In the statement of financial position, you will first show long-term assets at cost, then deduct total provision to separately state net book value
- Materiality
- The principle suggests that materially significant transactions should be recorded.
- It is not financially viable to record every materially insignificant transaction.
- For example, a mega cooperation will probably avoid listing stationary brought for offices like staplers as long-term assets, because it doesn’t make sense to record their depreciation every period.
- Material importance is based on whether an item’s inclusion or exclusion causes material change.
- Here, time and resources that would be wasted on recording insignificant items are preserved.
- All important information is recorded.
- Money Measurement
- Transactions that have monetary value and can be measured in money terms will be recorded in the books of accounts.
- Therefore, non-monetary assets are not recorded in the books.
- For example, inherent goodwill
- Purchased goodwill can be ascertained, and is recorded before writing off.
- Skill level
- Motivation level etc.
- For example, inherent goodwill
- Non-current assets are recorded at cost without any mention of their quality of efficiency.
- Prudence
- Prudence means doing things in a sensible manner
- Therefore, it requires two things
- Revenues not being mentioned more than they actually are.
- Losses and any expenses must be written off based on when they are incurred, instead of when they are paid,
- Occurrence of the something is the main determinant if its recording, not the payment.
- Bad debts provision and depreciation provisions are an excellent example of this concept’s application.
- For example, bad debts are anticipated to create a provision so we can write them off as soon as they are incurred.
- Provision for doubtful debts and provision for depreciation is created when we anticipate that depreciation has incurred.
- We can’t be sure about depreciation, but prudently, we create it to ensure that we are prepared for the future.
- Profits are NOT recorded if anticipated in advance
- We wait for the actual profit to occur before recording it.
- Every loss must be recorded (and matched as per matching principle)
- Prudence has the prevalence rule.
- In case it clashes with another principle, prudence principle prevails,
- Realization
- We realize revenues ONLY when the actual benefit of the transaction i.e. the good or service that the customer has purchased is delivered or provided.
- For example, if a customer pays today for a purchase, but the goods are actually received by them 2 days later, we will record the transaction as revenue 2 days later.
- Substance Over Form
- Form refers to the basic legal requirement or standing.
- Substance means the actual economic situation of something
- We should prefer showing the actual economic conditions of the items in the business instead of just meeting the bare minimum legal requirement.
- Therefore, substance must take precedence over form.
