Concepts, Conventions, Definitions

Question 1

What are the four fundamental principles of accounting?

Answer 1

1. The accruals (matching) concept
2. The consistency concept
3. The ‘going concern’ concept
4. The Prudence Convention

Question 2

What is the accruals (matching) concept?

Answer 2

Income earned or expenditure incurred should be charged to the period to which it relates, and not to any other.
E.g. a firm buys a machine for £12k in year 1. The machine is expected to last for five years, so the depreciation should be charged against each year’s profits, rather than at the end of the 5 years when sold

Question 3

What is the consistency concept?

Answer 3

1. Accounting policies must be adhered to year-on-year
2. Policies should not be changed without good reason
3. Such changes must be disclosed to shareholders in the annual report and accounts

Question 4

What is the ‘going concern’ concept?

Answer 4

1. We assume that a business will continue to survive and prosper (i.e. it is a ‘going concern’) unless the contrary is known to be true.
2. Therefore, historic cost values can continue to be used
3. If going concern assumption is not correct, current market value would have to be used as business is about to be wound-up.

Question 5

What is the Prudence Convention?

Answer 5

1. The Prudence Convention stipulates caution in making estimates under conditions of uncertainty
   such that…
   assets or income are not over-stated, and liabilities or expenses are not under-stated.

Question 6

What are the qualitative characteristics of financial statements?

Answer 6

1. Relevance, when information influences the economic decisions of users
2. Reliability, information should be free from material error and bias and can be depended upon
3. Comparability, should be possible to make comparison with previous accounting periods or with accounts from different companies
4. Understandability, information provided should be understandable by those with reasonable knowledge of business and accounting