topic 13 accounting concepts including inventory valuation

• Accounting concepts:

  • these are the rules accountants have to follow to maintain standards
  • the mnemonic to remember this is GAP CREMDOC
• Going concern:

  • when accounts are prepared it is assumed that the business is going to continue to operate for the foreseeable future and assets are recorded at cost
  • if a business were to cease trading, assets might have to be reduced to below cost, others might have risen in value
  • will have a bal cd in asset and liability accounts
• Accruals:

  • says that income statements should be based on income and expenditure rather than receipts and payments
  • also known as matching concept because revenue for an accounting year must be matched with expenditure relating to that year
• Prudence:

  • accountants must always assume the worst case/scenario and understate
  • profits are never anticipated until they are realised - sales are only recorded when they take place
  • losses are always anticipated and a provision is made for known expenses and losses as soon as business is aware of them
  • liabilities and losses are overstated
• Consistency:

  • means that once an accounting policy has been decided, the firm should continue to use the same policy in subsequent years when making financial statements unless there is good reason to change policies
  • if this is not followed, comparisons between years would be meaningless
• Realisation:

  • sales are recorded when the customer physically takes the goods and the sales invoice has been paid and vice versa with purchases
  • this gives rise with receivables and payables
• Entity (business):

  • owners of a business are regarded as completely separate from the business
• Materiality:

  • is relevant when making the distinction between revenue and capital items
  • only necessary to make this distinction if it makes a material (significant) difference
  • material difference depends on the level of the firm's revenue
• Dual aspect:

  • for every DR entry there must be a matching CR and vice versa
  • accounts must always balance
• Objectivity:

  • accountants do not show personal bias and transactions should be based on evidence like source documents
• Cost:

  • a company records assets on the SOFP at historical cost
  • this cost is not just the cost of the asset itself but any 'one off' expenditure associated with the acquisition of the asset and making it into a usable condition
• The importance of distinguishing between capital/revenue:

  • revenue items go in IS
  • capital items go in SOFP

  If no distinction is made between the two:

  • PFTY will be incorrect
  • net assets will be incorrect although the SOFP will still balance because of an error of principle has been made
  • financial statements will not present a true and fair view of the business
• Inventories must be valued at the lower of cost or net realisable value:

  • cost - how much the business originally paid for the goods
  • NRV - how much the goods could be sold for, less any costs in making the item into a saleable condition
• Accruals concept

  Also known as the matching concept because revenue for an accounting year must be matched with expenditure relating to that year