The Five Major Underlying Assumptions of Accounting

The five major underlying assumptions of accounting are:

1. Business Entity:

This concept explains that each business has a separate existence from its business and the entity is treated as an artificial judicial person distinct from its members. The effect of this assumption on the accounting of the company is that all the legal and contractual obligations are on the name of the company or entity and not on the name of the any individual member.

1. Going Concern (Continuity):

This assumption states that the business is not affected by its members as members may come and go the entity will not be affected. The effect of this assumption is on the accounting of the entity as accounting is done on the basis of the assumption that business will continue for long time and all the assets and liabilities are recorded accordingly.  

1. Periodicity:

This assumption says that the life of the entity can be divided into months and years depending on the accounting criterion and the contention of the accountants of the entity. Usually the term for the finalisation of accounts is to be taken as one year and quarterly and half yearly accounting can be done as per the requirements of the law (Tinkelman, 2015).

1. Money Measurement:

The money measurement concept says that the accounting of the entity is to be done in a common currency as this will make the financial statements comparable and the stakeholders and investors of the company can easily evaluate the financial statements. This is because entities are involved in the export and import transactions so they need to record all the transaction in the currency of the domicile of the entity.

1. Stable Dollar:

The stability dollar assumption states that the dollar is accepted as a stable unit of measurement. This accounting assumption states that the accounts need not to make any changes in the accounts and financial statements of the entity because of the fluctuations in the rate of the dollar. Although using the stable dollar assumption makes it difficult to do depreciation accounting.

The concepts that impact the accounting process of an entity are:

1. Accrual:

The accrual concept states that the revenues and expenses are recorded as and when they occur. This assumption states that either money is received or not or paid or not the happening of the transaction is relevant to recognise them in the books of accounts.

1. Consistency:

The consistency concept states that the entity will continue to follow the same measurement and valuations techniques until and unless there are any lawful requirement to change the same arises.

1. Conservatism:

The Concepts that Impact the Accounting Process of an Entity

The conservatism concept states that the revenues will be recognised as and when there will be any reasonable certainty to recognise them and expenses will be recognised when there will be reasonable possibility that they will be incurred.

1. Matching:

This concept states that the expenses relating to the revenue will be recognised in the same accounting year in the revenue is recognised. By doing this we can assure that all the aspects of a transaction are recorded in the same financial year.

1. Double Entry Concept:

This concept states that each transaction has two sided effect that means for every debit there is corresponding credit and vice versa.  This is based on the dual accounting aspect (Zeff, 2016).

The five major accounting principles are:

1. Exchange Price(or Cost) Principle:

Tis principle says that the transfer of resources is to be recorded at the price which I agreed to be paid at the time of the transfer.

1. Revenue Recognition Principle:

This principle states that the accountant cannot recognise the revenues until and unless they are earned or realised.

1. Matching Principle:

This principle state that the expenses incurred to earn the revenue are to be recognised in the same accounting year as and when the revenue is recognised (Henderson, Peirson, Herbohn & Howieson, 2015).

1. Gain and Loss Recognition Principle:

This principle states that the gains are recognised as and when they are earned and the losses are recognised at the time when the event resulting into loss has occurred.

1. Full Disclosure principle:

This principle states that the information which will affect the decision making process need to be disclosed in the financial statements or in the notes to accounts.

Modifying conventions are the practices that will change or impact the results obtained by the firm with the application of the accounting principles which are listed above. The three modifying conventions are:

1. Cost- Benefit:

The cost benefit modification says that providing financial information to the users is cost free but ideally this involves a lot of cost as the in preparation of financial statements.

1. Materiality:

This modification says that less expensive asset be recorded as an expense of the company and not to be depreciated over the useful life. This means that some unimportant material cannot be presented in the balance sheet.

1. Conservatism:

This says that an accountant needs to be prudent while preparing the financial statements of the entity to ensure that there must not be any understated or overstated figures. The overstated and understated financial statements can mislead the investors and other users of financial statement (Edmonds, Edmonds, Tsay & Olds, 2016).

1. Inventory is recorded at the lower of cost or market value. B. Conservatism
2. A truck purchased in January was reported at 80 per cent of its cost even though its market value at year-end was only 70 per cent of its cost. D. Going concern/ Continuity
3. The collection of $40,000 of cash for services to be performed next year was reported as a current liability. C. Earning Principle of revenue recognition.
4. The president’s salary was treated as an expense of the year even though he spent most of his time planning the next two years’ activities. G. Period Cost.
5. No entry was made to record the company’s receipt of an offer of $800,000 for land carried in its accounts at $435,000. B. Conservatism
6. A supply of printed stationery, checks, and invoices with a cost of $8,500 was treated as a current asset at year-end even though it had no value to others. F. Matching principle.
7. A tract of land acquired for $180,000 was recorded at that price even though it was appraised at $230,000, and the company would have been willing to pay that amount. E. Exchange price.
8. The company paid and charged to expense the $4,200 paid to Craig Nelson for rent of a truck owned by him. Craig Nelson is the sole stockholder of the company. A. Business Entity

References:

Edmonds, T. P., Edmonds, C. D., Tsay, B. Y., & Olds, P. R. (2016). Fundamental managerial accounting concepts. McGraw-Hill Education.

Henderson, S., Peirson, G., Herbohn, K., & Howieson, B. (2015). Issues in financial accounting. Pearson Higher Education AU.

Tinkelman, D. P. (2015). Introductory Accounting: A Measurement Approach for Managers. Routledge.

Zeff, S. A. (2016). Forging accounting principles in five countries: A history and an analysis of trends. Routledge.