Basic Accounting Concepts & Principles

Will complicated jargon please leave the area

Getting to grips with some basic accounting concepts is a great idea, especially as they to tend to build upon each other in layers, in a similar way to an onion.

These basic accounting principles, commence with some core conventions.

Historical Cost

The normal convention for preparing financial statements is that of historic cost. This means that if an item cost $100, then in the financial statements it will be recorded at $100. As a user of financial statements, it bears to keep this in mind when looking at accounts in times of high inflation.

True and Fair View

There would be little point in looking at financial statements if they did not try and show the real and underlying situation in respect of the financial condition of a business.

As such, any auditor of accounts, attests to them representing a true and fair view.

Going Concern

Values of assets in a business that is going to be dissolved or wound up are materially affected by not only supply and demand in the market, but the viability of the business to continue trading.

For this reason, in order for the accounts to be signed off satisfactorily as giving a true and fair view, consideration must be given to the fact that the business is a going concern.

This means that it can meet its debts and obligations as they fall due for the foreseeable future.

Basic Accounting - 3 Financial Statements

With these conventions in mind, one can now consider the basic accounting principles which underpin the production of financial statements, oh, and while we are talking about financial statements, there are three fundamental accounting statements:

• The balance sheet - statement of the financial position of a business at a given point in time.

• The income statement - a statement of the trading success of a business and its profit or loss across a period of time.

• The cash flow statement - a statement of the cash flowing in and out of the business, and how it was deployed to keep the business running.

Basic accounting concepts utilised when preparing the balance sheet

The balance sheet reports the assets and liabilities of a business, and some information about the ownership of those assets, most commonly called equity.

An asset is cash, an amount owed to the business from a customer (a debtor) or a strategic piece of equipment that will be utilised across more than one accounting period to deliver economic value to the business.

A liability is a debt whether it be owed to a bank, or a supplier or the owners of the business.

Basic accounting principles applying to the production of the income statement.

Revenue recognition.

Sales value (also called revenue and turnover) is recognised in the accounts in the period when the customer gains the use of the product, even if they don't pay for it until later.

The matching concept

means that the costs relating to the production, purchase and delivery of the product to the customer are recorded into the same period as when the sales are recognised. It also means that costs are recognised in the period in which they are incurred, as opposed to paid for.

Basic Accounting Concepts - The Accounting Equation

If you're anything like me, then at only the slightest mention of equation, I get cold shivers and memories of long nights of difficult homework. But not here.

The accounting equation relates to the relationship of items in the balance sheet, and is expressed simply as:

Assets = Liabilities + Owners Equity

What this means in lay terms is that, whatever is left over when you take what is owed from what assets there are in the business, then that belongs to the owners of the business. This is probably the most commonly discussed of the basic accounting concepts, as it underpins a great deal of the fundamentals of accounting.

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