2 Fundamental Accounting Concepts and Principles
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CHAPTER 2: FUNDAMENTAL ACCOUNTINGCONCEPTS AND PRINCIPLESBy Annie WPL
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LEARNING OBJECTIVESUnderstand the meaning of accounting
concepts and conventions.
Learn the basic accounting concepts and
conventions.
Conventions developed by the business and
its significant.
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ACCOUNTING CONCEPTS
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INTRODUCTIONAccounting concepts and principles are
general guidelines for sound accounting
practices.
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INTRODUCTION (CONTINUE)Accounting concepts are:
Business entity concept.
Dual aspect concept.
Going concern concept.Accounting period concept.
Monetary concept/money measurement concept.
Historical (cost) concept/cost concept.Matching concept.
Accrual concept.
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BUSINESS ENTITY CONCEPT Proprietor of an enterprise is considered
distinct and separate from the business.
Only the business transactions are recorded
and reported, and not the personaltransactions of the proprietor.
The personal assets of the owners or
shareholders are not considered whilerecording and reporting the assets of thebusiness entity.
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DUAL ASPECT CONCEPT This is the basic principle of accounting.
All business events/transactions are
regarded as having a dual aspect that is
twofold effect.
Each receiver is also a giver, and every giver
is also a receiver.
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DUAL ASPECT CONCEPT (CONTINUE) Example 1: Mr A purchases furniture for cash
RM1,000, he receives furniture on one hand,
and pays RM1,000 on the other. Thus the
twofold effect is Increase in one asset that is furniture.
Decrease in other asset that is cash.
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DUAL ASPECT CONCEPT (CONTINUE) Example 2, goods sold for cash. The two
aspects are
Cash received.
Giving away of goods.
The financial statements of a business
should reflect the twofold effect of each
business transaction.
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DUAL ASPECT CONCEPT (CONTINUE) Each transaction involves two entries, a debit
entry and a credit entry.
Every debit must have a corresponding
credit, and vice versa.
Since every debit has a corresponding credit,
the total debits must at any time equal the
total credits.
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GOING CONCERN CONCEPTA going concern is defined as any enterprise
which is expected to continue operating
indefinitely in the future.
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GOING CONCERN CONCEPT (CONTINUE) Significant of this concept:
Financial statements are prepared on the basis
of this concept.
Continuity of business activities are ensured tooutsiders over an indefinite period of time.
The fluctuations in the market value of fixed
assets is not taken into account.On the basis of this concept, a business is
judged for its capacity to earn profits in future.
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ACCOUNTING PERIOD CONCEPT The net income can be measured by
comparing the assets of the business
existing at the time of its commencements
with those existing at the time of itsliquidation.
Since life of business is assumed to be
indefinite, the measurement of incomeaccording to this concept is not possible for a
very long period.
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ACCOUNTING PERIOD CONCEPT (CONTINUE) The proprietor of the business cannot wait for
such a long period.
Therefore accountants choose some shorter
and convenient time for the measurement of
income.
Twelve months period is normally adopted
for this purpose.
This time interval is called accounting period.
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MONETARY CONCEPT/MONEY MEASUREMENTCONCEPT Every transaction is recorded in terms of
money.
A fact or happening which cannot be
expressed in terms of money is not recorded
in the account books.
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MONETARY CONCEPT/MONEY MEASUREMENTCONCEPT (CONTINUE) Example, general health condition of the
chairman of the company, quality of products,
sales policy pursued by the company,
general working conditions of a worker etc,cannot be expressed in terms of money.
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MONETARY CONCEPT/MONEY MEASUREMENTCONCEPT (CONTINUE) For example, if a business has a cash
balance of RM7,000, a building containing 20
rooms, a piece of land of 2,000 meters, 40
tables, 20 fans, 2 machines, one tone of rawmaterial and so on then in the absence of
money measurement concept these different
types of assets cannot be added to giveuseful information.
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MONETARY CONCEPT/MONEY MEASUREMENTCONCEPT (CONTINUE) But if they are expressed in monetary terms
RM7,000 cash, RM50,000 of building,
RM200,000 of land, RM8,000 of tables,
RM6,000 of fans, RM160,000 of machines,RM80,000 of raw material, it is possible to
use them for comparison or any other
purpose.
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HISTORICAL (COST) CONCEPT/COST CONCEPTAsset is recorded at the price paid to acquire
it that is at cost.
This cost is the basis for all subsequent
accounting for the asset.
This cost price at the time of purchase is
systematically reduced by the process called
depreciation.
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MATCHING CONCEPTAll expenses incurred in an accounting year
are compared with the revenues during that
year.
For this we have to recognise the revenues
or inflow during an accounting period and the
expenses incurred in securing those inflows.
Net income is arrived at by applying theformula
Net income = Revenues Expenses
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ACCRUAL CONCEPT The term accrual means something that
becomes due especially an amount of money
that is yet to be paid or received at the end of
the accounting period.
Revenue is realised at the time of sale of
goods or services irrespective of when the
cash is received.
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ACCRUAL CONCEPT (CONTINUE) The financial statements will not reveal true
and fair view of the affair of a business unit,
unless all the transactions or events of the
concerned year are brought into the books ofaccounts.
Expenses are recognised at the time the
services are received irrespective of whenactual payment for the service is made.
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ACCOUNTING CONVENTIONS
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INTRODUCTIONConventions are developed by business to
facilitate its recording of business
transactions in the books of accounts.
They help in comparison of accounting data
of different business units or of the same unit
for different periods.
The object is to make accounting data moreuseful.
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INTRODUCTION (CONTINUE)Accounting conventions are:
Convention of disclosure.
Convention of materiality.
Convention of consistency.
Convention of conservatism.
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CONVENTION OF DISCLOSUREAll accounts must be honestly prepared.
All material information must be disclosed
therein.
The balance sheet and profit and loss
account are to be prepared as per the law.
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CONVENTION OF DISCLOSURE (CONTINUE)All material facts must be disclosed
compulsory.
Financial statements including all their
related foot notes and other disclosure.
Should contain all of the relevant data
essential to users understanding of the
entitys financial status.
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CONVENTION OF MATERIALITYUnimportant items are either left out or
merged with other items.
If certain items are immaterial, then it does
not matter how you deal with it in theaccounts, because it cannot possibly haveany significant effect on the results.
The materiality convention allows the otherconventions to be ignored and a simpleraccounting treatment to be adopted.
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CONVENTION OF MATERIALITY (CONTINUE) It should be noted that an item of material for
one concern may be immaterial for another.
Similarly an item material in one year may
not be material in next year.
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CONVENTION OF CONSISTENCY It states that, once specific accounting
policies have been adopted, they should be
followed in all subsequent accounting
periods.
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CONVENTION OF CONSISTENCY (CONTINUE) For example, if a fixed asset is to be
depreciated, there are so many methods of
depreciation.
But a concern should follow the convention ofconsistency.
That is if one method of depreciation is followed
it should be consistently followed for all theyears.
Any change from one method to another will
result in inconsistency.
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CONVENTION OF CONSISTENCY (CONTINUE) It gives confidence to the users of accounting
statements, because if the accounts have
been prepared on a consistent, they can be
assured that they are comparable withprevious set of accounts.
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CONVENTION OF CONSERVATISM/PRUDENT This is the policy playing safe.
The need to make estimates and form
judgements when preparing financial
statements.
The conservatism states that, the accountant
should error the side of caution.
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CONVENTION OF CONSERVATISM/PRUDENT(CONTINUE) In other words, a prudent accountant will
tend to:
Understate revenue, profits and assets.
Overstate expenses, losses and liabilities.
It ensures that financial statements do not
give and over-optimistic view of the financial
performance and position of a business.
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QUESTION State which accounting concepts or conventions most
probably being adopted in dealing with the followingproblems:1. Electricity consumed in 2009 and paid for in 2010.
2. Equipment originally purchased for RM20,000, whichwould now cost RM30,000.3. A customer who might go bankrupt owing the company
RM5,000.4. The proprietor who has supplied the business capital
out of his own private bank account.5. Stock valuation method would be changed from AVCO
to FIFO.
p y
3