3. Accounting Theory

Question 1

Explain accounting entity/business entity concept and its implication to accounting practices?

Answer 1

Business is treated as a separate entity from its owner.

Implication:

1. Only business transactions are recorded in business books.
2. contribution of assets into business by owner will be recorded as “Capital”
3. withdrawal of assets by owner for personal use will be recorded as “drawings”

Question 2

Explain Going Concern.

Answer 2

Business entity is assumed to operate indefinitely.

Question 3

Explain Accounting period and its implication to accounting practices?

Answer 3

The life of the business divided into regular time intervals for the purpose of preparing financial statements.

Implication

Trial balance and financial statements are prepared as at and for a specific period of time.

Question 4

Explain Historical Cost.

Answer 4

All transaction should be recorded at its original cost

Question 5

Explain Monetary theory and its implication to accounting practices?

Answer 5

Only transactions which can be expressed in monetary terms are to be recorded.

Implication

The balance sheet / statement of financial position does not reflect the truth worth of the business as some non-monetary items are not included in the business record.

Question 6

Explain Objectivity theory.

Answer 6

There must always be objective verifiable evidence for reporting any accounting information. Financial statement should be free of personal bias and be based on facts rather than opinion.

Implication:

Hence business recorded transactions based on source document.

Question 7

Explain Matching theory and its implication to accounting practices?

Answer 7

Expenses incurred must be matched against income earned in the same period to determine the profit for the period.

Implication

1. Business charges depreciation of non-current assets end of the financial year.
2. Business estimates amount of debts uncollectible end of the financial year.

Question 8

Explain Prudence theory.

Answer 8

Accounting treatment chosen should be the one that least overstates assets and profits and least understates liabilities ae losses.

Implication:

1. Inventory is valued at lower of cost and net realisable value so at asset is not overstated
2. Business provides estimation of debts uncollectible end of the financial year so that asset is not overstated
3. business charges depreciation of non-current assets end of the financial year so that asset is not overstated

Question 9

Explain Accrual basis of accounting (accrual theory)

Answer 9

Business activities that have occurred, regardless of whether cash is paid or received, should be recorded in the relevant accounting period.

Revenue is recognized when is it earned and expenses is recorded when it is incurred in the relevant accounting period regardless of whether cash is received for revenue or paid for expenses.

Implication:

Business make adjustment for revenue earned and expenses incurred to be recorded in the financial statements.

Question 10

Explain Materiality concept.

Answer 10

Relevant information is considered to be material, should be reported in the financial statements if it is likely to make a difference to the decision making process.

It is a criterion used in classifying a capital expenditure or revenue expenditure of an item.

Question 11

Explain consistency theory.

Answer 11

Once an accounting method is chosen, this method should be applied to all future accounting periods to enable meaningful comparison.

Implication:

Method to calculate depreciation for non-current asset should not change from year to year.

Question 12

Revenue recognition theory

Answer 12

Revenue is earned when goods have been delivered or services have been provided.