See also:
Accounting Principles
Generally Accepted Accounting Principles (GAAP)
Financial Accounting Standards Board (FASB)
Income Statement
Balance Sheet
Arm’s Length Transaction
Materiality
Contra Asset Account
Basic Accounting Concepts
There are several accounting concept applications as they apply to the financial statements and general practice of a company. Some of these may be relevant and required because the company is publicly traded and must coincide with Generally Accepted Accounting Principles (GAAP), while smaller companies can pick and choose any of these basic accounting concepts as a best fit for their respective industries or business models. Aside from GAAP the Financial Accounting Standards Board (FASB) has also maintained detailed rulings as they relate to these listed concepts. Note that the following list does not contain all concepts of accounting. But rather, below is a list of perhaps what most would assume to be the most important ones.
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Entity Concept
The entity concept is one of the most general and easily understood accounting concept conventions. The entity concept simply states that an entity accounts for all transactions and business dealings only under that organization. The accounting concept simply draws a boundary around the organization in question so the organization can make decisions as they pertain to the specific transactions and accounts. The three types of entities are a Sole Proprietorship, Partnership, and a publicly traded Corporation.
Going-Concern Concept
Also known as the continuity concept, the going concern concept simply states that a business entity (see above) will continue to exist and remain in business in the remaining future. Picture a business that ceases to exist any longer. When this happens, the business has to liquidate or sell off the assets to pay off the liabilities first. Then the business distributes any remaining value to the equity holders. This is then a measure of the current value. However, if the business continues to grow and remain in business, then the business cannot easily measure the current value and it becomes a going concern.
Time Period Concepts
The Time period concept simply states that financial information i.e. the balance sheet, income statement, and statement of cash flows should be provided in regular time intervals. For publicly traded companies or corporations, the Securities Exchange Act of 1934 requires this. This act requires corporations to issue quarterly statements known as 10-Q and annual statements (known as a 10-K). The law does not require private companies to issue reports. But it is good practice to do so, so that well informed decisions can be made about the company.
Stable Monetary Unit Concept
Due to Globalization the world is much more accessible to people as well as businesses. Because of this businesses receive payment in several different currencies as they conduct business in other countries. Therefore it becomes necessary to list all of the assets in the same monetary terms so that all accounts can remain in a neat and orderly fashion. The Stable-Monetary Unit Concept also ignores the effects of inflation and the ever changing value of currencies – which are exchanged in the open market.
Materiality Concept
The materiality concept simply states that a company must strictly state accounts and transactions that are significant to the organization’s operations. An account or transaction is material if it’s inclusion in the financial statements were to change a statement user’s decision. Immaterial items are insignificant. They are also not required to be strictly or specifically stated because the inclusion or exclusion of them would not change a user’s opinion. It should be noted that materiality does not mean that a company does not have to account for every transaction. Instead, it states that the accuracy of these transactions is not as important.
Conservatism
The accounting concept conservatism simply states that accounts and transactions should contain realistic and not overly optimistic results in the current period or the future. For example, the LIFO method of accounting and the lower of cost or market (LCM) is generally used because both of these methods postpone the recording of net income. Therefore, they are more conservative or paint the company in a more realistic light.
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