Business Entity Concept
This says that only transactions affecting the business are recorded in the business books of accounts and, consequently, the final accounts. Capital introduced or withdrawn is recorded in the proprietors capital account and drawings account.
Example: Money spent on a holiday for the preprioter can't be included as 'office expense' or 'travel expense' - this should be recorded as 'drawings'.
If the inclusion or exclusion of financial information would mislead the users of the accounts, then the information is 'material'. The concept recognises that some types of expenditure are less important than others, so absolute precision of recording such items is not essential.
Example: A pencil eraser costs 84 pence and is expected to be used in the office for four years. So, technically, the eraser is a fixed asset. It should, strictly speaking, be shown on the balance sheet as a fixed asset. In reality, it would be entered in the office expenses or sundry expenses. This classification is unlikely to cause the final accounts to confuse the users.
All assets and expenses are recorded in the books of accounts at cost since this is the objective.
Example: My vintage car cost £18,000. I think that it is now worth £20,000. Cost of £18,000 is objective but my valuation of £20,000 is subjective so should not be used ( as it will misled users).
Going concern Concept.
Unless there is information on the contrary, the accounts of the business are prepared under the assumption that the business will continue to trade in its present form for the foreseeable future.This means that all assets are valued at cost, not at what they could be sold for if they were actually sold. If the business is going to continue to trade, the assets will not be sold and so sale value is irrelevant.
Example: My business premises cost £200,000. Similar premises have been sold last week at £240,000. The amount shown on the balance sheet will be:
Premises at cost 200,000
The value of resources used by a business and the benefits derived from the use of those resources are recorded in the books of accounts in the financial year. The value, to the business, of resources used may be different from the amount paid during the financial year to acquire the resources.
Example: Rent paid during the financial year ended 31 March 2009 was £7,200. At the year end, £800 remained unpaid for the financial year. £8,000 would be shown on the profit & loss account (the total rent for the year ended 31 March 2009) and £800 would be shown as a current liability - accured rent ( the amount outstanding at the end of the financial year).
Consistency requires that once a method of treating information has been established, the same method should continue to be used in subsequent years. If different methods are used in different years, inter-year comparisons can't be made reliably and any trends can't be observed.
Example: Arthur wishes to change the annual rate of depreciation charged on his vehicle from the usual 20% (£30,000) to 10% (£15,000) this year to improve his reported profits. Such an action would violate the concept of consistency and make it difficult to compare this years result with those in the previous years.
Revenue and profits are only included in the accounts when they are realised. Provision is made for all known expenses or losses when they become known.
Example: -Tariq will sing a contract for £150,000 of work on 7 January next year - one week after his financial year end. He intends to include £150,000 in this years final accounts. The concept of prudence doesn't allow this as the £150,000 can only be included when the sale actually takes place.
-Martin wll provide £1,700 to cover potential debts afte scrutinising the debts outstanding at the year end.
This states that profits are usually recognised when title to the goods passes to a customer, not necessarily when money (price) changes hands. A sale takes place when the goods are replaced with cash or with an assets (debtor). The realisation concept is a subset of the accruals concept.
Accountants must be objective; that is, view the business and its transactions in a dispassionate way. The records should not be subject to personal bias. To avoid this, financial information should always be verified by referring to a source document.
Example: Mary has inherited a Victorian ring from her Aunt Bessy. She recently had the ring valued at a local antique shop. The proprietor valued it as being worth £200. He wished to purchase the ring for this amount but Mary said that it was Aunt Bessy's favourite ring and that even if he offered £5,000 for it, she wouldn't sell it. Mary valued the ring at £5,000. An accountant should value it at £200.