5 Accounting Assumptions Flashcards

The SEC regulates the financial reporting of companies selling their shares in the United States, whether US GAAP or IFRS are used. The basics of accounting discussed in this chapter are the same under either set of guidelines. The financial results reported by a business should cover a uniform and consistent period of time. If this is not the case, financial statements will not be comparable across reporting periods.

Income Statement Under Absorption Costing? (All You Need to Know)

Verifying the accuracy of the accounting record is one of the essential purposes of audit activity. So, auditors not only need to collect audit evidence but need to verify its appropriateness. Hence, the assessment of reliability for the accounting record is one of the essential objectives of the auditor. An auditor is responsible for assessing the appropriateness of the management’s assumption that the company is going concerned. It can be done by collecting sufficient and appropriate audit evidence and observing if there is something to believe the company is not concerned about. The going concept has great significance for the stakeholders like shareholders, suppliers, customers, employees, and others as their return depends on its financial stability.

The role of Accounting Assumptions in Business Studies

Economic Entity Assumption – Under the economic entity assumption, an economic activity can be identified to a separate entity accountable for that activity. Be aware that while many corporations align their fiscal 5 accounting assumptions flashcards years with calendar years, others do not. Consistency Principle – all accounting principles and assumptions should be applied consistently from one period to the next. Stakeholders can compare the business performance across several periods, observe trends, assess performance, and make significant decisions such as investment, strategic planning, and so on. Interestingly, for economies experiencing hyperinflation, the International Accounting Standards Board (IASB) requires financial reports to be adjusted for changes in purchasing power using an inflation index. This shows how standard accounting practices are modified in extreme situations to compensate for the limitations of the Monetary Unit Assumption.

Still, the following are some warnings/signs that help to assessability of the business to remain a going concern. For example, if a company pays an annual insurance premium in advance, this payment will not completely be treated as an expense in the month it was paid. Instead, this expense is spread over the entire year, each month carrying an equal portion of the premium as an expense, matching the time period it covers. A business is assumed to have an indefinite life ( we do not show items at their liquidation or exit values). Meet the people who work hard to deliver fact based content as well as making sure it is verified. Imagine, for instance, a furniture business that purchases lumber, paint, and other supplies and then uses these materials to produce tables, chairs, and other pieces.

Business transactions should never be mixed with the business owner’s personal transactions in accounting practices. The ultimate goal of any set of accounting principles is to ensure that a company’s financial statements are complete, consistent, and comparable. This makes it easier for investors to analyze and extract useful information from the company’s financial statements, including trend data over a period of time. Accounting principles also help mitigate accounting fraud by increasing transparency and allowing red flags to be identified. Generally Accepted Accounting Principles (GAAP or US GAAP) are a collection of commonly-followed accounting rules and standards for financial reporting. This accrual basis of accounting gives a more accurate picture of financial events during the period.

Time Period Assumption in Accounting

While creating the financial reports, the accountants must strive for full disclosure.The monetary unit assumption means that only transactions in U.S. dollar amounts can be included in accounting records. It’s important to note that accountants ignore the effects of inflation on the recorded dollar amounts. GAAP is a set of rules used for helping publicly-traded companies create their financial statements. These rules form the groundwork on which more comprehensive, complex, and legalistic accounting rules are based. It assumes that the company will not go bankrupt and will be able to meet its obligations and objectives.

• The basics of accounting discussed in this chapter are the same under either set of guidelines.
• The FASB and IASB sometimes work together to issue joint standards on hot-topic issues, but there is no intention for the U.S. to switch to IFRS in the foreseeable future.
• While the differences between the two accounting systems are basic, the sheer number of non-cash economic events that happen in a business are numerous, leading to a system that can be intimidating.
• Understanding these assumptions is crucial for effective business analysis and financial reporting.
• Consistency Principle – all accounting principles and assumptions should be applied consistently from one period to the next.

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Having a consistent method of accounting will ensure an easy comparison between the financial statements of a company for different financial periods. This assumption makes it mandatory for the companies to record only such accounting transactions that can be easily proven. In other words, financial transactions that can be proven through invoices, billing statements, receipts, and bank statements must only be recorded in the financial statements.

• Footnotes supplement financial statements to convey this information and to describe the policies the company uses to record and report business transactions.
• The application of the economic entity concept has significant importance because of the following reasons.
• These are not represented in financial statements, revealing another limitation of the Monetary Unit Assumption.
• For instance, a depreciable amount is charged in different periods based on the estimate.
• Losses and costs—such as warranty repairs—are recorded when they are probable and reasonably estimated.

In other words, the set of financial statements can only be compared when accounting treatment and presentation of both financial statements are the same; otherwise, there will be a need to make adjustments. While the Time Period Assumption is fundamental to accounting, it’s not without its effects and limitations. As it requires financial statements to be prepared periodically, accountants must make certain estimates for carrying over some costs and revenues across periods.

Assumptions, Accounting Principles (conceptual framework) Flashcards

Maintaining consistency in accounting methods will ensure that accounting records over several accounting periods can easily be compared. An economic entity concept states that a business is a separate entity from its owners or other businesses. If there is no separation of accounting records, it will not be possible for the reader to assess the business’s financial performance.

The owner’s personal transactions should not interfere with the business’s financial records, making the business an independent entity. The balance sheet, income statement, and cash flow statement – all these key financial statements rely on this assumption to present the business activity in terms of a stable monetary unit. The concept of the Monetary Unit Assumption, as it is aptly named, implies that all financial transactions should be recorded in a single monetary unit, such as the US dollar, British pound, or any other national currency. Through this assumption, the accounting systems maintain consistency, comparability and simplicity. The consistency principle states that an accounting policy/method, once adopted, should be consistently practiced.

Even though the customer has not yet paid cash, there is a reasonable expectation that the customer will pay in the future. It defines the mechanism for the reporting of financial transactions in the financial statements. These are a set of rules that makes it mandatory for the companies to conduct their business operations and reporting mechanism as per the standards laid out by the FASB. Transactions are recorded using the accrual basis of accounting, where the recognition of revenues and expenses arises when earned or used, respectively.