Chapter 14

How acounting concepts/principles are applied when preparing the final accounts.

How accounting concepts are applied to the valuation of inventory of goods for resale. 

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Accounting concepts

There are 9 accounting concepts.

Business entity - The personal assets and liabilities of the owner of a sole trader business are kept separate from those of the business.

Materiality - Some items that have a low monetary value that there is not much point in recording them saparately as they are not 'material' like stationary.

Cost - Assets and liabilities are recorded in the final accounts at historical cost. This means the balance sheet valuations are objective and there can be no dispute about the amount shown.

Going concern - Presumes the business will continue to trade in the forseeable future. The income statement and balance sheet are prepared on the basis there is no intention to reduce significantly the size of the business or to liquidate it.

Accruals/matching -
Expenses and income are matched to the same time period. The income statement shows the amount of expense that should have been incurred and income that should have been recieved.

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Accounting concepts (2)

Consistancy - When a buisness adopts accounting policies, it should conitnue these policies consistantly. If a business decided to depreciate an asset for 10% each year using the straight line method, they should continue to use that percentage and method for future accounts for the asset.

Prudence - also known as conservatism. In the final accounts, where there is any doubt a conservative (lower) figure should always be reported for profit and the valuation of assets. It prevents an over optimistic presentation of a business through the final acoounts.

Realisation - Business transactions are recorded in the final accounts when the legal ownership passes between buyer and seller. It not be at the time as payment is made

Objectivity -  The presentation of final accounts should be objective ratehr than subjective and is not influenced by the opinions of the owner or accountant. It is supported by business documents.

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Valuation of inventory

At the end of the financial year, it is essential for a business to make a physical inventory count for use in the final accounts.

Inventory is valued at:

  • either what it cost the business to buy - including costs to bring the product to its present location and condition like delivery costs
  • or net realisable value - the actual estimated selling price less further costs such as repairs.

The inventory valuation is often described as being the lower of cost and net realisable value.

This means both inventory values are compared and the lower figure is chosen. 

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