Accounting Principles and Policies | Accounting for GCSE/IGCSE - Year 11 PDF Download

Accounting Principles

Business Entity/Accounting Entity and Ownership

• A business owner is considered distinct from the business itself. Their personal assets, expenditures, and debts are separate from those of the business.
• Transactions are recorded solely from the business's perspective. The owner's financial activities are not directly reflected in the business's accounting records.
• In cases where a transaction involves both the owner and the business, it is accounted for either in the capital account, the drawings account, or the current account.

Duality/Dual Aspect

• Every financial transaction involves two aspects: giving and receiving. This principle is fundamental in double-entry bookkeeping.

Money Measurement

• Only information that can be quantified in monetary terms is recorded in accounting.
• Intangible aspects like employee morale or competitive threats, which lack a precise monetary value, are not included in financial records.
• Money serves as a universally accepted unit for assessing the value of transactions, ensuring objectivity and comparability.

Realisation

• Profit recognition should align with when it's earned, meaning it's only recorded when the buyer legally owns the goods or services and is obligated to pay for them.
• Merely confirming the purchase of goods holds no significance until the legal ownership of the goods transfers from the seller to the buyer.
• Even if goods are sold on credit and the customer hasn't yet paid, income is still recorded, adhering to this principle of profit recognition.

Going Concern

• Businesses are assumed to continue operating indefinitely without any plans of closure or significant downsizing.
• Accounting records are maintained under the assumption of continuity, valuing non-current assets at their Net Book Value (cost minus depreciation).
• Inventory is valued at the lower of cost or net realizable value.
• If there is an expectation of business closure in the near future, asset values can be adjusted to reflect market values, making the financial statements more meaningful.

Historical Cost

• Ledger accounts capture assets and expenses at their original purchase cost.
• Occasionally, a more cautious stance is adopted, leading to the depreciation of non-current assets to align their value closer to a net realizable value.
• Implementing this principle can complicate financial comparisons, particularly in inflationary contexts. Prudence consistently takes precedence over Historical Cost.

Accounting Period

• Because reports need to be generated regularly, a business's lifespan is segmented into accounting periods, typically annual cycles.
• This segmentation allows for meaningful comparisons with the business's performance over time. At the end of each accounting period, total expenses are transferred to the income statement. Balances remaining at the period's close, which don't pertain to that specific financial year, are carried forward as the opening balance of the subsequent trading period.
• The concept of going concern assumes that the business will continue operating indefinitely. Thus, financial statements are structured around annual divisions to reflect this perpetual operation.

Consistency

• When presented with a selection of methods, it's imperative to adhere to the chosen approach consistently across subsequent accounting periods.
• For instance, if the reducing balance method is selected to depreciate delivery vans, it should be consistently applied.
• Failure to adhere to this principle would hinder the ability to compare financial statements between different accounting periods.

Accruals/Matching

• Revenue for a specific period is matched against the corresponding expenses related to that period.
• For instance, consider insurance prepaid for two months at the end of an accounting period, totaling $40. At the start of the same period, insurance due amounts to $20, and insurance paid is $300.
• Therefore, the insurance relevant to the current accounting period equals $300 (paid) - $40 (prepaid) - $20 (from the previous period).
• This practice extends the principle of realization and encompasses other expenses and income.

Prudence

• The principle aims to depict an accurate portrayal of the business in its accounting records.
• It advocates for the avoidance of overstating profits and assets while ensuring liabilities and expenses are not underestimated, and potential losses are duly acknowledged (such as through the maintenance of provisions for doubtful debts).
• Recognition of profit is only appropriate once all conceivable losses have been duly recognized.
• Prudence takes precedence over other principles; for instance, bad debts are written off within a specific period, despite income being realized. Additionally, provisions are established for depreciation and potential bad debts.

Materiality

• Items of minimal value, such as low-cost non-current assets or sundry expenses, are either consolidated or documented in a manner that may overlook other principles.
• Insignificant non-current assets, which incur more expenses to account for spreading their cost over their useful life, are expensed. For instance, office supplies inventories are often deemed immaterial and therefore not included in financial statements.
• A multinational corporation may not classify the purchase of a laptop as capital expenditure, unlike sole traders who typically would.

Accounting Policies

• Policies established by the IAS govern the maintenance of international accounting records.

Selection of Accounting Policies and Principles

• Relevance: Financial information is crucial if it influences business decisions, guiding future actions and strategies. For example, when a company evaluates whether to invest in a new project based on the financial data provided.
• Reliability: Financial information should be trustworthy and accurate, devoid of errors or biases. This ensures that stakeholders can rely on the information for decision-making. For instance, accurate financial reporting helps investors assess the company's performance.
• Understandability: Financial reports should be easily comprehensible to users with basic accounting knowledge. Complex jargon or omitted information may hinder understanding. For instance, a clear breakdown of financial statements aids investors in interpreting the company's financial health.
• Comparability: To make meaningful comparisons between financial reports of different periods or companies, similarities and differences in accounting policies must be identified. This enables stakeholders to assess performance trends and make informed decisions. For example, comparing the financial performance of two companies operating in the same industry requires consistent accounting principles.