Going Concern Concept in accounting:
Separate Entity Concept
The separate entity concept should also be applied to the operating divisions of a business, so that we can separately determine the same information for each division. The concept is more difficult to apply at the division level, for there is a temptation to allocate corporate expenses to each of the subsidiaries; this makes it more difficult to ascertain profitability and financial position at the operating unit level.
An owner cannot remove funds from a business without recording it as either a loan, compensation, or an equity distribution. Otherwise, the owner may buy something (such as real estate) and leave it on the books of the business, when in fact the owner is treating it as a personal possession.
An owner cannot extend funds to a business without recording it as either a loan or a stock purchase. Otherwise, undocumented cash appears in the business.
An owner is the sole investor in a building, and arranges to have his business operate from that building in exchange for a monthly rent payment. The business should report this payment as an expense, and the owner should report it as taxable income.
Accrual Concept
Accruals within a business are significant processes that help ensure the company’s financial statements properly reflect its financial health. Following the accrual concept means transactions are recorded even if payments for certain services have not been fully paid.
In this article, we will give you a detailed analysis of the accrual concept in accounting, its importance, examples and journal entries and how it differs from the matching concept.
Importance of Accrual Concept
Understanding the accrual concept is important for various reasons, especially since it helps in the accurate preparation of financial statements. Here are some points of significance of accrual accounting.
- Assessment of Business Performance
The performance of a business is assessed more accurately due to the application of the accrual concept. This is because accruals are portrayed in financial statements that indicate the financial health of the company. This happens due to the availability of information on accounts payable and receivable. Instant portrayal of where money is coming from and going out is expected in future reports, making performance assessment easy.
- Planning Future Financials
Accrual accounting is important as it is implemented in the business in real time, making it easy for management to have a detailed overview of finances. It also allows the accountants to assess progress from previous financial years and compare it with the present to plan for the future on an appropriate budget.
- Accurate Results
When accrual accounting is implemented in a company, it depicts a more accurate position of business finances. As debts and income of the firm are properly outlined, it helps the company manage its financials per business activity patterns.
- Implementation of the Matching Principle
The accrual method uses the matching principle method, an important factor in business accounting. In this case, expenses and revenues are reported in the same period and are ‘matched’ to determine profits or losses of that financial period.
Consistency Concept
The consistency concept is a key idea in accounting, which highlights how crucial it is for an organization to employ the same accounting procedures, practices, and policies over time. It guarantees that financial statements are similar among intervals, making it possible for stakeholders to assess the performance and role of an entity’s price range with accuracy. Companies must maintain consistency by applying constant accounting methods for similar transactions and occurrences for the duration of reporting intervals and refrain from making frequent adjustments to accounting guidelines unless needed. Organizations can gain trust among traders, creditors, regulators, and other customers of economic factors using upholding regular accounting techniques, which improve the dependability, credibility, and transparency of their economic reporting.
Geeky Takeaways:
- Consistency in accounting methods is crucial for ensuring comparability in financial reporting.
- Consistency helps mitigate bias and distortion in financial reporting.
- If accounting methods are changed frequently, it can lead to fluctuations in reported financial results that may not necessarily reflect the underlying performance of the business.
Materiality Concept
Some transactions are too small to be recognized in any financial accounting statement. Such transactions might not impact the analysis of the financial statement by an external observer; the removal of such irrelevant information to keep the financial statement crisp and consolidated is called the materiality concept accounting.
It is to be understood that materiality is a subjective concept that guides a company to identify and disclose only those transactions that are sufficiently large compared to the company’s operations such that it would concern the users of the company’s financial statements.
Dual Aspect Concept
The dual aspect concept is a core principle of accounting and forms the basis for the double-entry accounting method. It states that every transaction has two equal and opposite effects on the accounts of a business. This concept ensures that every financial activity is recorded in a way that keeps the accounts balanced and presents a true picture of the business’s financial position.
Whenever money, goods, or services are exchanged, there is always a giver and a receiver. For each transaction, if one account is increased, another is equally decreased or increased in an opposite way. In accounting records, this is reflected through a system of matching debits and credits for every entry. This dual impact is what keeps the bookkeeping accurate and reliable.
Each transaction is recorded in two accounts. If one account increases, another account will either decrease or increase in a corresponding way. This is called the double-entry method. An example will help clarify:
- If a person borrows ₹5,000 from a friend, his cash account increases by ₹5,000 while his liability (amount owed) also increases by ₹5,000.
- When a company purchases a computer for ₹1,000, the value of “Computers” (asset) increases by ₹1,000 but the cash in the bank account decreases by ₹1,000.
Every business transaction—whether it’s taking a loan, selling a product, or buying equipment—will always have this double-sided entry in the accounts. This ensures no imbalance in the books and supports transparency.
