Basic Accounting Assumptions
Financial statements are multipurpose documents used by many different parties for different reasons. Management use them to control their business and to make useful business decisions. Bank managers use them to decide whether loans and overdrafts should be given. Suppliers use them to decide whether credit terms should be extended. Investors use them to decide whether to invest or not.
For this reason financial statements need to be based on a generally agreed accounting framework or structure so that all parties understand how they are produced. Accounting assumptions can be considered to be the foundations on which this accounting framework is based.
What are the Accounting Assumptions?
The four basic accounting assumptions are as follows:
Money Unit Measurement Accounting Assumption
Everything is recorded in terms of money. Items which cannot be recorded in terms of money are ignored and not included. It follows that the financial statements only give a partial picture of the state of a business. This is sometimes referred to as the monetary unit assumption.
Economic Entity Accounting Assumption
For accounting purposes the business is treated as a separate entity from the owner. The accounting records show transactions of the business not the owner.
Going Concern Accounting Assumption
Accounting assumes the business will continue for a long period of time and transactions are recorded on this basis.
Time Period Accounting Assumption
The business should report its financial activities over a fixed time period usually annually, quarterly or monthly. This is sometimes referred to as the periodicity assumption.
Accounting Assumptions and Accounting Principles
Accounting assumptions are one part of a framework established by an agreed set of accounting principles, as illustrated in the diagram below.
The accounting principles diagram is available for download in PDF format by following the link below.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.