Accountants should be cautious in the valuation of assets or the measurement of profit. The lowest reasonable estimate of an asset's value should be taken whilst a forecast loss would be included but not a forecast profit. This is also known as the 'conservatism' principle.
The prudence principle is of great importance to users of the accounting information,
as it ensures that the accounting summaries have not been drawn up on the basis of
over-optimistic or speculative forecasts, and that foreseeable losses and expenses
have been included.
True and fair view
The overall aim of the financial statements should be to present a true and fair view of the business's financial position and performance. Truth and fairness are difficult concepts to define . However, if the financial statements follow the principal qualitative characteristics described above and also follow relevant laws and accounting standards then this normally results in a 'true and fair view'.
For large businesses, an independent report from a firm of auditors will state whether
in their opinion, the financial statements show a 'true and fair view'.
Materiality concept
Materiality refers to the significance of information contained within financial statements. It is considered significant if its inclusion could influence the economic decisions of the users.
If information is immaterial, then it does not need to be disclosed separately, or in any
other way that gives it undue significance. For example, if a business's communications
budget consisted of £10,000 paid for mobile phone usage and £20,000 paid
for other phone calls, this could be amalgamated as one total of £30,000 without any
effect on the value of the information to users.
Business entity concept
The personal financial affairs of the owner or owners of the business should be kept separate from those of the business itself.
A private holiday paid for out of the business's bank account must not be treated as a
business expense.
Dual aspect concept
Financial transactions of a business have two aspects, both of which must be shown within the financial recording system.
For example, a business buying a machine with a cheque for £10,000 results in the
business's bank account decreasing whilst the asset of 'machinery' increases by
£10,000. Similarly, if a business receives a cheque for £500 following a sale of
goods, the bank account will increase but inventories will decrease.
Money measurement concept
This assumes that all relevant financial information is capable of being measured in a common currency, regardless of the nature of the items being measured. This enables dissimilar items to be aggregated within the financial statements (e.g. a supermarket's buildings can be added to the supermarket's delivery lorries).
Not everything that affects a business can be measured in money terms. For example,
how do you measure the value of a dynamic managing director, a contented and productive
workforce or a poor record of dealing with customers' complaints?
Historic cost concept
Under this concept, when presenting a statement of a business 's financial position, the values of assets are based on the original price paid rather than a subsequent valuation which adjusts the value for factors such as inflation. As we shall see later in the book, this concept is often modified to reflect material changes in significant assets - particularly land and buildings.
What would be a true and fair view of a business's assets, if it had bought a plot of
land for £1 million in 2001, and that land had a market value of £4 million in 2008?
It would be hard to argue that the historic cost of £1 million reflected a reasonable
valuation in 2008!
Elmer Tamayo is the author of myaccountinginfo.net who took-up his degree of "BS in Accountancy" major in accounting. A Web designer and blogger, His passion is Reading books, searching new tech update on the world wide web. Read More...
