Unit 2: Accounting Concepts, Principles and Conventions - 2 Chapter Notes | Accounting for CA Foundation PDF Download

Fundamental Accounting Assumptions

There are three basic accounting assumptions:

1. Going Concern
2. Consistency
3. Accrual

All three fundamental accounting assumptions are explained in paragraph 2.5. If the financial statements do not mention these assumptions, it is presumed that they have been adhered to in the preparation of the financial statements. However, if any of the aforementioned fundamental accounting assumptions are not observed, this must be explicitly disclosed.

Financial Statements

Qualitative Characteristics of financial Statements

Qualitative characteristics are the attributes that enhance the usefulness of information in financial statements for users. The key qualitative characteristics include:

• Understandability: Financial statement information must be easily comprehensible to users, assumed to have a reasonable understanding of business, economics, and accounting. Complex information relevant to economic decisions should not be excluded simply due to its difficulty.
• Relevance: Information must be pertinent to users' decision-making needs. Its relevance is determined by its ability to influence economic decisions, aiding in the evaluation of past, present, and future events, or confirming past evaluations. The predictive and confirmatory roles of data are interconnected, enhancing the ability to foresee financial outcomes based on past transactions.
• Reliability: Information ought to be reliable, meaning it should be free from material error and bias, accurately representing what it claims to depict. Relevant but unreliable information can mislead users regarding its truthfulness.
• Comparability: Users should be able to compare financial statements over time to identify trends and evaluate different enterprises. Consistent measurement and display of similar transactions across time and enterprises enhance comparability. Transparency in accounting policies is essential for clarity in comparisons.

Materiality: The relevance of information is influenced by its materiality, which pertains to whether its misstatement could sway economic decisions. Materiality acts as a threshold, not a primary characteristic.

Faithful Representation: To ensure reliability, information must accurately represent the transactions and events it claims to depict. Financial statements should reflect the true nature of transactions rather than merely their legal form.

Substance over Form: Accurate representation of transactions requires accounting based on their economic reality rather than their legal form. For instance, if ownership changes are pending legal formalities, the transaction should still be recorded based on its economic substance.

Neutrality: Reliable financial statements must be unbiased, avoiding any influence on decisions through selective presentation of information.

Prudence: Financial statement preparers must recognize uncertainties surrounding many events and apply caution when making estimates. Prudence entails careful judgment to avoid overstating assets or income and understating liabilities or expenses.

Full, Fair, and Adequate Disclosure: Financial statements should fully disclose relevant information to assist users in making informed decisions. Compliance with generally accepted accounting principles ensures that financial details accurately reflect the economic reality.

Completeness: For reliability, financial statement information must be complete within the limits of materiality and cost. Omissions can render information misleading, so it should faithfully present the economic reality of transactions, not just their legal form. 

Summary

• Accounting concepts define the assumptions on the basis of which financial statements of a business entity are prepared. The following are the widely accepted accounting concepts:
  (a) Entity concept
  (b) Money measurement concept
  (c) Periodicity concept
  (d) Accrual concept
  (e) Matching concept
  (f) Going Concern concept
  (g) Cost concept
  (h) Realisation concept
  (i) Dual aspect concept
  (j) Conservatism
  (k) Materiality 
• Accounting principles are a body of doctrines commonly associated with the theory and procedures of accounting serving as an explanation of current practices and as a guide for selection of conventions or procedures where alternatives exist.” 
• Accounting conventions emerge out of accounting practices, commonly known as accounting principles, adopted by various organizations over a period of time. 
• There are three fundamental accounting assumptions:
  (i) Going Concern
  (ii) Consistency
  (iii) Accrual 
• Qualitative characteristics are the attributes that make the information provided in financial statements useful to users. Understandability, Relevance, Reliability, Comparability, Materiality, Faithful Representation, Substance over Form, Neutrality, Prudence, Full, fair and adequate disclosure and Completeness are the important qualitative characteristics of the financial statements.