Accounting Theory: Underlying assumptions or concepts Saylor Academy

According to the periodicity (time periods) assumption, accountants divide an entity’s life
into months or years to report its economic activities. Then, accountants attempt to prepare accurate
reports on the entity’s activities for these periods. These time periods are usually of equal length so
that statement users can make valid comparisons of a company’s performance from period to period. For instance, so far, the
income statements in this text were for either one month or one year. Revenue and expense recognition timing is critical to transparent financial presentation.

• GAAP ensures companies generate clear, comprehensible and comparable financial data regardless of industry, status or affiliations.
• There is no universal GAAP standard and the specifics vary from one geographic location or industry to another.
• Together, these principles are meant to clearly define, standardize and regulate the reporting of a company’s financial information and to prevent tampering of data or unethical practices.
• Data gathered in an accounting system must relate to a specific business unit or entity.
• If there is a period of time where revenue was recognized on sold products or services, then the cost of those things should also be recognized.

The issue of differing accounting principles is less of a concern in more mature markets. Still, caution should be used, as there is still leeway for number distortion under many sets of accounting principles. Accounting principles are the rules and guidelines that companies and other bodies must follow when reporting financial data. These rules make it easier to examine financial data by standardizing the terms and methods that accountants must use.

BUS103: Introduction to Financial Accounting

Another key accounting assumption that persons working towards an accounting degree will need to understand is the going concern assumption. This assumption assumes that the business in question will likely continue operating in the foreseeable future. It assumes that the company will not go bankrupt and will be able to meet its obligations and objectives. The going concern assumption presumes that the business will be operating beyond its next fiscal period, will complete its expected plans, and meet its projected goals. With such a prominent difference in approach, dozens of other discrepancies surface throughout the standards.

It also stresses more emphasis on the earning capacity in judging the overall performance of the business. As a result transactions should be recorded in the books of accounts with such persons and individuals together with the owners. It becomes necessary that accounting records of the business must be maintained in a manner which is free from any bias to any particular section of people related to it. As such, accounts are maintained for business entity as distinguished from all categories of persons related to it. The going concern assumption assumes a business will continue to operate in the foreseeable future. However, one should presume the business is doing well enough to continue operations unless there is evidence to the contrary.

Where Are Generally Accepted Accounting Principles (GAAP) Used?

The role of the Auditor is to examine and provide assurance that financial statements are reasonably stated under the rules of appropriate accounting principles. The auditor conducts the audit under a set of standards known as Generally Accepted Auditing Standards. The accounting department of a company and its auditors are employees of two different companies. The auditors of a company are required to be employed by a different company so that there is independence.

• Publicly traded companies (those that offer their shares for sale on exchanges in the United States) have the reporting of their financial operations regulated by the Securities and Exchange Commission (SEC).
• Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.
• The ending account balance is found by calculating the difference between debits and credits for each account.
• This assumption assumes that the accounting records of a business and the personal accounting records of the business’ owner will be kept separate.

Though only regulated and publicly traded businesses are legally obligated to follow GAAP, some private companies also choose to meet the same standards in financial statements. A potential or existing investor wants timely information by which to measure the performance of the company, and to help decide whether to invest. Because of the time period assumption, we need to be sure to recognize revenues and expenses in the proper period. This might mean allocating costs over more than one accounting or reporting period. A potential or existing investor wants timely information by which to measure the performance of the company, and to help decide whether to invest. GAAP is a set of procedures and guidelines used by companies to prepare their financial statements and other accounting disclosures.

What are the Key Accounting Assumptions?

IFRS is designed to provide a global framework for how public companies prepare and disclose their financial statements. Today, IFRS is the preeminent international accounting standard for financial reporting, and 144 out of 166 countries or jurisdictions around the world use IFRS. Although GAAP and IFRS serve the same fundamental purposes, there 5 Key Accounting Assumptions are some key differences between them, including the following. GAAP specifications include definitions of concepts and principles, as well as industry-specific rules. The purpose of GAAP is to ensure that financial reporting is transparent and consistent from one public organization to another, and from one accounting period to another.

The going concern concept assumes that an organization would continue its business operations indefinitely. It means that it is assumed that the business will run for a long period of time, and will not liquidate in the foreseeable future. It is because the going concern concept provides the firm with the basis to show its assets’ value in the balance sheet. Many countries around the world have adopted International Financial Reporting Standards (IFRS).

Gift Card Revenue Recognition

Even though Lynn feels the equipment is worth $60,000, she may only record the cost she paid for the equipment of $40,000. Business Entity Concept – is the idea that the business and the owner of the business are separate entities and should be accounted for separately. Monetary Unit Assumption – assumes that all financial transactions are recorded in a stable currency. Companies that record their financial activities in currencies experiencing hyper-inflation will distort the true financial picture of the company. Cost Benefit Principle – limits the required amount of research and time to record or report financial information if the cost outweighs the benefit.

Thus, if recording an immaterial event would cost the company a material amount of money, it should be forgone. Element of reliability on the financial statements is essential for the external stakeholders like shareholders, suppliers, tax authorities, and other business partners as they rely on that. The practice of appending notes to the financial statements has developed as a result of the https://kelleysbookkeeping.com/ principle of full disclosure. The financial statements must disclose all the relevant and reliable information which they purport to represent so that the information may be useful for the users. According to this principle, the financial statements should act as a means of conveying and not concealing. The accounting data should consistently stay accurate and be free of personal opinions.