Basic Accounting Concepts
Financial statements, balance sheets, income statements, and cash flow statements are multipurpose documents relied on by many different users to provide objective and accurate financial information about a business. For this reason, they are produced within a generally agreed framework based around established accounting principles whose foundation is the four accounting assumptions.
The accounting assumptions are supplemented by a number of accounting concepts (sometimes referred to as accounting principles), which act as guides on how particular business transactions should be reported in financial statements, and allow them to be objective (not subject to bias or influenced by personal feelings or opinions).
What are the Fundamental Accounting Concepts?
The following are the main accounting concepts to consider when preparing financial statements:
- Revenue Realization Accounting Concept: Revenue is considered as earned income when it is realized, this is at the time the goods or services are passed to the customer and the customer incurs liability for them.
- Matching Accounting Concept: Expenses are matched to revenues within an accounting period. Profit is therefore the difference between revenue and expenses not cash received and paid. This accounting concept is sometimes referred to as the accruals accounting concept.
- Full Disclosure Accounting Concept: Financial statements should disclose fully and completely all significant information.
- Historical Cost Accounting Concept: Assets are normally shown at cost price in the balance sheet, and this cost is the basis for all subsequent accounting for the asset. The balance sheet does not show the current value of an asset.
- Dual Aspect Accounting Concept: There are two sides to accounting, one represented by assets (receive benefits) and the other represented by liabilities (give benefits). This is basically a statement of the accounting equation Assets = Liabilities + Capital. The method of recording this dual aspect is called double entry bookkeeping.
- Verifiable and Objective Evidence Accounting Concept: Each accounting transaction should have adequate (verifiable) documentary evidence to support it, and this evidence should be free from bias (objective).
Accounting Concepts and Accounting Principles
Accounting concepts are one part of a framework established by an agreed set of accounting principles, as illustrated in the diagram above.
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 in 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 BSc from Loughborough University.