Some Basic Concepts

The Money Measurement Concept

An accounting record is made only of information that can be expressed in monetary terms. It does not reflect how strong the management is, the staff relationship or the reputation of the organization. However, in a public listed company, such information will be reflected in its profit and loss conditions and subsequently in its share value. The major disadvantage of this concept is its historical nature. The value appeared in an accounting record is the value recorded at the time when it is incurred. The value has no clear indication of its purchasing power at the time when one is using the information.

The Entity Concept

Accounts are kept for entities as distinguished from the persons who are associated with these entities. When a person puts $2M into his business, the "business" owes the person $2M. This concept extends to units within an organization. The head quarter is one entity and a service centre is another. When money is transferred from the head quarter to the service unit, the accountant would have to "credit" the head quarter and "debit" the service unit. This concept is fundamental in "debits" and "credits" which many beginning accountants sometimes find difficult. For example, your organization has 4 separate bank accounts. In the accounting books, you have a "cash account" and 4 "bank accounts". When you put $1,000 into bank A from your cash box, you credit the "cash account" and debit the account of Bank A. Bank A "owes" $1,000 to the cash account $1,000, not to you.

The Going-concern Concept

Unless there is good evidence to the contrary, account assumes that an entity will continue to operate for an indefinitely long period in the future. In other words, we do not assume that the entity is going to be liquidated within a short period of time or will be bought out by another enterprise. For example, the assets in the balance sheet do not reflect their "realizable" value. It simply reflects the remainder of cost minus depreciation as far as the law permits. For showing a better profit and loss statement to a potential investor, the business would prefer a slower rate of depreciation. That is why in the beginning years of a business they may prefer to use a longer depreciation period and for business making profits they would like to increase the rate of depreciation. For many non-profit organizations, these are not much of their concern and thus they depreciate their assets to a value of $1 in the same year of purchase, just to keep them in the books.

The cost concept

The value of assets is recorded as the acquisition cost. The market value, current worth or replacement cost is not recorded. Sometimes, in accounting reports, we find the item "Good will" which reflects the value of an intangible and valuable economic resource purchased by the enterprise. Sometimes, people think that "good will" is the accountant's appraisal of what the company's name and reputation worth.

The Dual-aspect concept

Similar to the accounting practice of double-entry system (debit one account and credit another account at the same time), an asset is always coupled with an equity.

Assets are economic resources controlled by an entity whose cost at the time of acquisition could be objectively measured.

Equities:

1. owner's equity or capital (Some people choose to classify this as a form of liability)
2. Liabilities - the claims of creditors.

Assets = Equities (or Assets = Liabilities)

The Conservatism Concept

It states that when accountants have a reasonable choice as to how a given event should be recorded, they ordinarily choose the alternative which results in a lower, rather than higher, asset amount.

The Balance Sheet

Current Assets (cash, marketable securities/unit funds/accounts receivable/inventory/ prepaid expenses, etc.)

They include cash and other assets that are reasonably expected to be realized in cash or sold or consumed during the normal operating cycle of the business or within one year.

Accounts receivable normally refers to amounts owed to the entity by its customers/clients. An amount owed to the entity other than a customer/client would appear under the heading of other receivables. If the amount owed is evidenced by a written promise to pay, it is listed as notes receivable. Sometimes, there will be provisions called "allowance for doubtful debts accounts".

Non-recurrent/Fixed Assets

These items mainly include land or building property and equipment. The acquisition cost and the accumulated depreciation are usually included in the balance sheet.

Current Liabilities (accounts payable, notes payable, bank drafts payable, estimated tax liability, accrued expenses payable, deferred income, bonds payable, etc.)

Current liabilities are obligations that are expected to be satisfied either by the use of current assets or by the creation of other current liabilities.

Accounts payable are the claims of suppliers related to goods or services they have furnished to the entity for which they have not yet been paid.

Accrued expenses payable are the converse of prepaid expenses which should be paid and not yet paid.

Deferred income represents the liability that arises because the entity has received advance payment for a service it has agreed to render in the future.

Non-current liabilities/other liabilities/long-term debt - Payment due in some future period beyond the next year.

Equity (Owner's equity, Retained Earnings)

Some organizations use "surplus" instead of retained earnings in the balance sheet.