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Fundamental Financial Accounting Assumptions, Principles & Conventions

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Accounting assumptions are those wide-ranging concepts that emphasize commonly agreed accounting principles. These assumptions are rubrics of game and they have materialized from consensus.

Fundamental Financial Accounting Assumptions, Principles, and Conventions | Core Concepts

Fundamental Assumptions, Principles, and Conventions- Financial Accounting Concepts accounting Fundamental Financial Accounting Assumptions, Principles & Conventions Fundamental Assumptions Principles and Conventions Financial Accounting Concepts
Fundamental Assumptions, Principles, and Conventions | Financial Accounting Concepts

Accounting is a skill, and not a discipline like math, in which methods can be authenticated by regular regulations. A commonly accepted set of guidelines can provide a unity of accepting and also a unity of approach in the practice of accounting.

In constructing the structure of accounting theory and to relate the theory to accounting practice, the accounting profession has permitted to take for granted certain fundamental ideas.

Accounting assumptions are those wide-ranging concepts that emphasize commonly agreed accounting principles. These assumptions are rubrics of game and they have materialized from consensus.

Certain concepts are assumed or agreed in accounting with an intention to providing a combining theoretical structure and internal reasoning of accounting.

Accounting Rules

To be acceptable in accounting practice, accounting rules must gratify the following factors;

  1. They rest on realistic assumptions;
  2. They are internally steady;
  3. They characterize the modest, most freely graspable justifications of the field of accounting;
  4. They have the utmost predictive value; and
  5. They gratify the data requirements of the users.

It is mandatory to have a look at and understand those assumptions, which often refer to either in theory or in practice.

These assumptions are in some cases refer to as concepts, conventions or policies. Others refer to several combinations of concepts, conventions, principles, assumes, and policies.

These concepts are known as underlying concepts in financial accounting and they have a substantial control on the practice of accounting.

Assumptions

 

The fundamental financial accounting assumptions for the preparation and presentation of financial statements are as follows:

Going concern assumption:  In general, it is to be assumed that the business is going to be functioning for a long period of time in future. By taking this assumption into consideration, assets and liabilities are valued on the basis of past cost and on that basis; balance sheet signifies the true and reasonable outlook of the state of affairs of a concern on a specific date.

Since it is assumed that the business will continue in future, this concept can also be termed as continuity concept.

Separate entity assumption:  The business is an entity that is separate and distinct from its owners, so that the finances of the firm are not co-mingled with the finances of the owners.

Consistency financial unit assumption:  For a clear and correct representation of interpretation in financial statements, it is highly essential to follow consistency.

Consistency use of accounting measures and procedures is vital in attaining comparability.  Comparability means that the data is presented in such a method that a decision maker or the users of accounting data can distinguish comparisons, modifications, and developments over different time phases or between the enterprises.

The consistency convention involves that an accounting process, as soon as implemented by an enterprise, remains in use from one period to the next unless users are learned of the change.

Fixed time period assumption – The information is being prepared and subsequently reported at times (i.e. quarterly, annually).

Principles

The fundamental assumptions of accounting result in the following accounting principles:

Historical Cost Principle: Financial accounting, as presently practised, is still mainly based on historical cost. For instance, the past cost needed to acquire an asset on the data of acquisition (the cash equivalent acquisition cost).  Assets are informed and presented at their original cost and no adjustment is made for changes in market value.

Matching and Accrual Principle: The matching principle is connected closely to accrual accounting and revenue recognition.

The matching principle illustrates that to determine the income of a company for an accounting period, the company calculates the overall expenses involved in gaining the revenues of the period and related these total expenses to the total revenues noted in the period.

An enterprise distinguishes and matches expenses against revenues on the basis of three principles.

  1. Association of cause and effect,
  2. Systematic and rational allocation, and
  3. Immediate recognition.

Revenue recognition principle: Recognition refers to the process of properly recording and reporting an item in the financial statements of a company. A recognized item is shown in both words and numbers, with the amount contained within the financial statements sums.

Entrepreneurship

Human Resources

Leadership

marketing

Operations

Strategy

There are four key elements that determine the recognition criteria. To be recognized, an item must;

  • meet the definition of an element
  • be measurable
  • be relevant
  • be reliable

Full disclosure principle: There is a common consensus in accounting that there should be ‘full’, ‘fair’ and ‘adequate’ disclosure of accounting records. Full disclosure requires that financial statements be planned and organised to represent perfectly the economic measures that have affected the firm for the period and to contain adequate data to make them advantageous and not misleading to the average investor.

More clearly, the full disclosure principle indicates that no data of substance or of concern to the average investor will be mislaid or hidden. 

Modifying Conventions (or Constraints)

The freedom of choice that is left to managers is how they report financial results has, however, over the years been progressively constrained by a growing body of ‘Generally Accepted Accounting Principles (GAAP).

These principles or standards are framed in different means in different nations, but whenever they exist they constitute a body of rules that limit the freedom of the managers of business entities to exercise their own favourites as to how the finances of their businesses are to be reported on.

As a result of practical constraints and Industry practice, GAAP principles are not always applied strictly but are improved as needed.

The following are some frequently observed modifying conventions:

Materiality convention: Materiality is fundamentally, a substance of professional judgement. An individual item should be judged material if the knowledge of that item could reasonably be deemed to have influence on the users of the financial statements.

Materiality convention refers to as modifying convention that lowers certain GAAP requirements if the influence is not big enough to impact decisions. Users of the data should not be overstrained with information burden.

Cost-benefit convention: The cost-benefit convention holds that the benefits to be increased from providing accounting information should superior than the costs of providing it.

Of course, minimum levels of relevance and reliability must be touched if accounting information is to be beneficial.  A modifying convention that relaxes GAAP necessities if the anticipated cost of reporting something surpasses the benefits of reporting it.

Conservatism convention: When accountants are uncertain about the judgements or estimates they must make, which is frequently the case, they look to the convention of conservatism.

This conservatism holds that when confronted with selecting between two equally suitable procedures, or estimates, accountants should choose the one that is least likely to overseas assets and income. When there is a choice of equally suitable accounting methods, the firm should use the one that is least likely to overstate income or assets.

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Fundamental Financial Accounting Assumptions, Principles & Conventions

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