Effects of Assumptions on the Accounting Process
The accounting process is influenced by five assumptions: business entity, going concerned, money measurement, stable dollar, and periodicity.
The business entity concept recognizes that a business exists independently of its owners, creditors, employees, customers, and other companies. Financial statements are prepared specifically for the business entity’s activities, resources, and obligations and are reported separately. However, large corporations may establish different legal entities for reporting purposes while still considering them part of the same entity due to joint stock ownership.
BUS 3061 Unit 4 Assignment 1 Proprietorship Business Transactions
The going concern assumption assumes that accountants will operate under the belief that the business will continue its operations indefinitely unless there is evidence of its discontinuation. This assumption guides accountants in valuing assets, as they rely on historical costs rather than market values. However, if a business is expected to cease operations, the going concern assumption no longer applies, and market values become relevant when selling assets.
The money measurement assumption states that economic activities should be reported in monetary terms. By using a standard monetary unit, such as the dollar, accountants can effectively report and compare economic activities, such as the effects of equipment and inventory on the balance sheet. However, conversions need to be made for accurate comparisons when dealing with foreign currencies.
The stable dollar assumption is another aspect of money measurement. It assumes that a dollar is a regular unit of measure and that financial accountants do not adjust primary financial statements for dollar value changes. However, this assumption can create challenges in depreciation accounting, as the straight-line method needs to account for dollar value changes over time. Inflation can impact long-term assets depreciated over many years.
BUS 3061 Unit 4 Assignment 1 Proprietorship Business Transactions
The periodicity assumption divides financial reporting periods into equal lengths, usually months, quarters, or years. These reports provide helpful information for investors, creditors, and managers to make informed business decisions. However, estimations for depreciation and other adjusting entries may introduce inaccuracies for specific periods.
Accountants must make approximations and exercise judgment to ensure usefulness while recognizing that precise measurements may only sometimes be attainable. With the periodicity assumption, businesses would only have a single period from inception to discontinuation, rendering cash-basis or accrual-basis accounting concepts meaningful.
Effects of Accounting Concepts on the Accounting Process
Several accounting concepts influence the accounting process, including general-purpose financial statements, substance over form, consistency, double-entry, and articulation.
General-purpose financial statements are produced regularly, usually monthly for internal users and quarterly for external users, to provide an overview of a company’s financial position. While these statements are unbiased and reflect the company, specific business decisions may require additional information not included in the general-purpose reports. In such cases, accountants gather data from detailed accounting records to create purpose-specific notifications.
The substance-over-form concept emphasizes recording business transactions based on their economic substance rather than legal form. Accountants record transactions based on the actual nature of the transaction, even if its legal form suggests otherwise. For example, if a lease arrangement is deemed economically equivalent to a purchase, it should be recorded as such.
BUS 3061 Unit 4 Assignment 1 Proprietorship Business Transactions
Consistency is a concept that promotes using the same accounting practices and principles consistently across accounting periods. It prevents companies from changing accounting practices to present a more favorable financial picture or manipulate information to benefit specific parties. If a company decides to change its accounting practices, full disclosure of the change and its cumulative effect on past income must be provided in the financial statements.
The double-entry concept states that every transaction has equal and opposite effects on the parties or companies involved. This concept ensures that the accounting system maintains balance and serves as a system of checks and balances to identify errors. The debits and credits must balance out. If there are any discrepancies, accountants must look into them and make corrections to ensure accuracy.
Articulation refers to the interconnection between different financial statements. The information reported in one account should align with those in other related words. This ensures consistency and accuracy in financial reporting, allowing users to analyze and interpret financial information effectively.
These accounting concepts are crucial in guiding the accounting process and ensuring financial information’s reliability, comparability, and usefulness.
Impact of Generally Accepted Accounting Principles on Financial Reporting
Generally Accepted Accounting Principles (GAAP) are standards designed to govern accounting practices and ensure consistent and reliable financial reporting. These principles include concepts and rules guiding financial information recognition, measurement, presentation, and disclosure. Let us explore how some of these principles affect financial reporting:
a) Exchange Price Principle: This principle requires that resources exchanged in a transaction be recorded at the agreed-upon price at the time of the exchange. It ensures that transactions are recorded at their fair value and reflect the economic substance of the business. It applies to external transactions and self-constructed assets recorded at their actual cost.
b) Revenue Recognition Principle: The revenue recognition principle outlines specific conditions for recognizing revenue. It states that payment should be recognized when earned and can be reliably measured.
This principle acknowledges that cash may be received before or after the delivery of goods or services, resulting in two types of revenue recognition: accrued revenue and deferred revenue. Accrued payment recognizes revenue in the same accounting period as it is earned, while deferred revenue recognizes revenue in a later period.
BUS 3061 Unit 4 Assignment 1 Proprietorship Business Transactions
c) The Matching Principle is an accounting rule that states expenses must be recorded in the same period as the revenue they relate to. This ensures that all costs incurred in generating revenue accurately match that revenue. While some expenses, such as product costs, are compared directly with income, others, such as payroll costs, are recognized when incurred.
d) Gain and Loss Recognition Principle: This principle governs the recognition of gains and losses in financial reporting. Revenues are recorded when realized, meaning they are recognized upon the completion of a transaction. On the other hand, losses are recognized when they are apparent, even if they have not been realized yet. For example, gains resulting from the sale of long-term assets above their book value are only recognized upon the sale.
e) Full Disclosure Principle: The entire disclosure principle requires the disclosure of all material information that could impact the decisions of users of financial statements. It aims to provide transparency and ensure that users have access to relevant information. This principle can be achieved by including additional disclosures in the financial statements or supplementary notes.
Impact of Modifying Conventions on the Accounting Process
Modifying conventions are practices or customs that may deviate from strict adherence to accounting principles in specific circumstances. They provide flexibility in the application of accounting standards. Let us explore a few modifying conventions and their impact on the accounting process:
a) Cost-Benefit Convention: The cost-benefit convention considers the cost of providing optional information in financial statements and weighs it against its benefits. This convention acknowledges that not all information may be worth its preparation and disclosure cost. Accountants evaluate whether the expense of providing specific information is justified by its advantages.
b) Materiality Convention: The materiality convention states that items should be treated in a manner that is not theoretically correct but is practical and expeditious. It allows for the expedited treatment of immaterial things that do not significantly impact financial statements—for example, recording less expensive assets as an expense right away instead of depreciating them over time.
c) Conservatism Convention: The conservatism convention emphasizes prudence and caution in financial reporting. It suggests that accountants anticipate and recognize potential losses, but gains should only be realized when inevitable. This convention helps prevent overstating assets and net income, ensuring financial statements do not mislead users.
Matching Procedures with Principles, Assumptions, or Concepts
Matching Procedures with Principles, Assumptions, or Concepts:
Inventory recorded at the lower of cost or market value
The matching principle is applied when inventory is recorded at a lower cost or market value. If the stock’s market value falls below its price, it should be recorded at a lower value to ensure that expenses match the revenues they generate.
In January, a truck was bought at a total price, but by the end of the year, its value had decreased to 70% of the original cost. However, it was reported at 80% of its actual price.
The going concern/continuity assumption is reflected in this situation. Despite the decline in market value, the truck is reported at 80 percent of its cost, indicating the belief that the business will continue its operations and be used for future periods.
The collection of $40,000 cash for services to be performed next year is reported as a current liability.
The revenue recognition principle guides this procedure. The revenue recognition principle states that revenue should only be recognized when earned. Although the cash has been received, the services are yet to be performed. In this situation, the income will be made when services are provided in the next accounting period.
Even though the president spent most of their time planning activities for the next two years, their salary was still an expense in the current year.
This procedure aligns with the period cost principle or the principle of immediate expense recognition. Even though the president’s activities will benefit the company in the next two years, his salary is recognized as an expense in the current year related to the period in which it is incurred.
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
The realization principle applies in this case. The company has yet to make an entry to recognize the receipt of the offer because the realization of the gain or loss on the sale of land should be recorded only when the transaction is completed. Until the deal is finalized, the company continues to carry the ground at its original recorded value.
The supply of printed stationery, checks, and invoices for $8,500 was treated as a current asset at year-end, even though it had no value to others.
The matching principle is again employed in this procedure. The supply of stationery, checks, and invoices is considered a current asset at year-end to ensure that the expense matches the period in which it will generate revenue. Although it may not have value to others, it is necessary for the company’s operations and revenue generation.
A tract of land acquired for $180,000 was recorded at that price even though it appraised at $230,000, and the company would have been willing to pay that amount.
The exchange-price (cost) principle is applied here. Even though the land is appraised for a higher value, the exchange-price code focuses on the actual cost incurred by the company. The land is recorded at its acquisition cost of $180,000, adhering to the principle that assets should be initially recorded at their cost.
The company paid and charged to expense the $4,200 paid to Craig Nelson for the rent of a truck he owned. Craig Nelson is the sole stockholder of the company.
This procedure relates to the business entity concept, which recognizes the company’s separation from its owners. This concept ensures that the company’s financial transactions are distinct from those of its owners. The company paid and charged the rent expense, treating the transaction as if it were with an external party, despite Craig Nelson being the sole stockholder.
References
- Bonham, M., ProQuest Ebooks, Ernst & Young. International Financial Reporting Group, February, I. & Books24x7, I. (2008). International GAAP 2008: Generally accepted accounting practice under international financial reporting standards (1st ed.). Chichester, West Sussex, England: J. Wiley & Sons.
- Edwards, J. D., Hermanson, R. H., & Maher, M. W. (2011). Accounting principles: A business perspective, financial accounting (Chapters 1-8). Textbook Equity.
- Reineking, C., Chamberlain, D. H., Rudolph, H. R., & Smith, L. M. (2013). Examining inventory costing convergence under generally accepted accounting principles and international financial reporting standards. Journal of International Business Research, 12(2), 17.
- The Wall Street Mojo (2020). Revenue Recognition Principle. Principles of Revenue Recognition. Retrieved from:
https://www.wallstreetmojo.com/revenue-recognition-principle/
