AQA Applied Business - Unit 15

All the accounting concepts

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  • Created by: Damini
  • Created on: 23-01-13 11:27

Going Concern

Assumes that the business will continue trading into the foreseeable future.  As the business is viable, its assets are worth more than those of a business, which is about to close.  If a business is assumed to be a going concern, then the value of its assets are listed at their current worth to the business.

 

i.e. Business Worth = Value of Assets

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Accruals or Matching Concept

Profit is not simply a measurement of cash in minus cash out.  This concept states that the measurement of profit is the difference between the revenues the business has earned and the costs (expenses) involved in earning those revenues during the financial period being considered.  This statement does not say that these costs must have been paid for.  So this is the practice of placing costs incurred and revenues generated by a business in the financial periods in which goods and services were used and products were sold.  This is not necessarily when payment were actually made.

Think about electricity being paid for in arrears.

Think about credit sales.

It is known as matching, because the practice is to match a cost or revenue to the financial period when the transaction took place, not when the payment changes hands.

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Consistency

The application of a uniform approach to accounting policies when presenting accounts.  Think about a car.  To Ford it is stock, to other businesses it is an asset.  Once the firm has decided on a method for how an item should be treated, it should stick to that method year in year out.  This allows accounts to be consistent and comparable year in year out.

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Prudence

This approach accounts for losses as soon as they are anticipated (immediately), and accounts for profits only when they are realised.  If payment is promised by a customer and therefore recorded, what happens if that customer never actually pays?  The reason for this practice is that it would be unwise for an accountant to overstate the value or profits of a business.  Owners or potential lenders might think the business is doing better than it actually is therefore causing the business to overextend itself or for people to lend it money when it is not really such a safe prospect.

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The Realisation Concept

This ties in with the idea of prudence.  Profits are only recognised one they have happened in reality - in financial terms this is called being realised.

  • goods and services have been provided
  • monetary value (price) has been agreed
  • the buyer either pays or accepts responsibility to pay (credit)
  • the payments are actually made (one or all instalments)

This won't be the case is someone defaults on paying for their goods, such as a car.  The car will be repossessed and the profit on the sale will not be realised.

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Materiality

This concept assesses the impact an individual items of the presentation of accounts.  If any stakeholder could be misled by the exclusion of inclusion of an item in the accounts, then that item is regarded as being important, therefore material. If it is not, then the business should not waste their time in the sophisticated recording of trivial items.

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Business Entity Concept

This describes the idea that the financial affairs of the business and the owner are seperate.  When preparing the business accounts, we are only concerned with the business itself, not the actions of the owner.  Therefore we ignore private transactions regarding their personal assets or liabilities.

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Money Measurement Concept

Only transactions, which can be measured in money terms, are recorded in a business's accounts.  Accounts can never provide you with everything you may need to know e.g. staff motivation may be a key factor in success, but you can't measure commitment in monetary terms.

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The Duality Concept

This outlines the view that every transaction has two effects, one positive and one negative.

A customer goes to buy a car - the positive effect is that the business has made a sale and will receive payment and the negative effect is that the business now has less stock and will need to buy some more.  From this we can assume that the two effects are equal in value and therefore will always balance.  From this comes the accounting equation.

The accounting equation is the formula that forms the basis of the balance sheet.

assets = capital + liabilities

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The Duality Concept (...continued)

Let's simplify it to assets + capital firstly.  All the resources or assets in the business are equal to the amount of money or resources the owner has invested.  The start up capital buys the equipment necessary and the remainder is put in the bank ready to spend.

If we go back to the original equation and bring in liabilities we can see the effect.  A loan is taken out to pay for a van.  The loan is a liability, however the van has a worth which shows as an asset.  Any remaining money is put into the bank.  So the accounting equation will always hold true.  This is because any money introduced into a business will either be spent or left in the form of bank or cash.  This in turn gives rise to the format of recording financial transactions known as double entry.

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