Basic Accounting Concepts

To understand the accounting you are required to understand some basic concepts of it. These include
1) Going Concern
2) Prudence
3) Matching Concept
4) Consistency
5) Materiality
6) Substance over form

Going Concern
Going concern concept implies that the entity will continue to operate in the foreseeable future and has not any intentions or necessity to liquidate. Assets should not be measured on realizable ( selling) value.

Example:

ABC Foods Pty has acquired a grinding machine costing USD 100 million with nil residual value. Assets has a life of 10 years.
Using the going concern assumption, it is assumed that business will remain in operation and asset will live out its total life of 10 years. A depreciation charge of USD 10 million ( USD 100m/10 years) would be made each year. The value in the balance sheet for the asset would be cost less accumulated depreciation.

Prudence

Prudence concept is about the exercise of the judgement needed in making the estimates. According to the prudence concept, assets or income should not be overstated and expenses or liabilities should not be understated.

Example:

Loss of USD 150m by ABC foods pty due to damage of premises by fire should be accounted for immediately. An accurate estimate is needed to be accounted for.
Profits or incomes should only be recognized when realized in any asset.

Matching Concept

Matching means expenses, income and profits and losses of a certain period should be matched with each other.

Example:

Let say ABC foods pty incurred an expense of USD 450 and earned an income of USD 650. The income and expense should be matched in the relevant period.

Consistency

The presentation and classification of items in the financial statements should remain the same from one period to another except in case of any significant change in the nature of operations.

Materiality

Materiality is an important concept in the accounting which implies that all material information should be disclosed adequately.

What is material information?

Any information which can influence the economic decision of the users taken on the basis of financial statements.

Substance overform

The principle that the transactions are recorded on the basis of their nature and not only with regard to their legal form. In accounting the substance of the transaction is far more important than the legal form of it.

For example a car leased by the company should be recorded in the books of the company as a leased asset not merely rental expense.