Accounting Principles

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Accounting Principles: The generally accepted rules that govern the way
accounting information is generated.
There are 7 (CHER @ MCG)
The accounting principles allow us to approach accounting from a common
perspective, these principles govern the way accounting information is
recorded.
These principles will justify all your actions in accounting so ALWAYS be able to
pinpoint the principle that allows for an action to occur and justify it in your
head. They all have a 1) Reason in line with purpose of accounting 2)
Implication 3) Way to identify.
Entity
Entity: The business is assumed a separate entity from the owner and other
entities and all accounting records and reports should be kept on this basis.
Transactions of the business must be kept separate from the personal
transactions of the owner and of other entities.
All assumption principles have the :records and reports should be kept on this
basis addition to its definition:
Essentially, that in terms of classifying entities, we ALWAYS look at the firm in a
separate light as we consider it a separate entity.
If we are to assess the performance of the firm itself we must only include
information relevant to the business and business decision making.
TIPS on identifying this principles usage: Look for autonomy, firstly we need to
have two entities in the scenario for this to be an entity principle breach or
usage ( NOT ALWAYS EXPLICITLY STATED ). They generally involve maintaining
autonomy or breaching it so always examine: is this firm a separate entity in
this scenario – 1) are other firms influencing it? 2) are the other entities
financial information/data being confused with the firms data?
The owner can have multiple firms so do not get them mixed up EG Qantas vs
Jet connect.
Justification: Only transactions made in the name of the firm are taken into
account as they are relevant for the business and business decision making.

Implications
- The capital account
- Transactions between the firm and the owner
A business must have a separate bank account which should only be used
for business purposes
- When the owner uses it for personal usage : Drawings
- When owner contributes and asset (usually NCA or cash ) : Capital
Contribution
CAPITAL CONTRIBUTION OF A NCA
There is no source document to verify the sale between the owner and the
firm for non-cash assets (memo does but we are referring to the historical cost
of that asset) and hence and agreed value become the new historical cost.
The entity principle stops us from using the original purchase price of the
assets as it is the price that the entity purchases the asset for that matters
hence an AV is needed.
Agreed Value: The accepted value of a non cash asset at the time of its
contribution by the owner
When a Non cash asset is donated, the entity principle states it must be valued
at and agreed value and not at the original purchase price paid by the owner
(historical cost).
Agreed value = 6,000
Historical Cost = 10,000
We use agreed value as it is a better representation of that vehicle and its
worth to the business (its ability to generate revenue for the firm) and hence it
is more useful and relevant for decision making.

Going Concern Principle

Going Concern Principle: The life of the business is assumed to be
continuous and its records are kept on that basis
This is an assumption principle hence we tag it with “assumed to be
continuous and its records are kept on that basis”
Justification: Allows us to record transactions that have an effect on
the future
Implications
1) Classification: To ensure that we report our assets and liabilities
correctly, allows us to consider the future of our assets and
liabilities. Essentially we can distinguish between noncurrent
and current assets and liabilities by detailing how much affect
they will have on the future.
The classification of an asset/Liability tells us two things:
- How much of our ASSET/LIABILITY will be gone in the future?
- How much will be left?
2) Allows us to distinguish between assets and expenses, assets
provide benefit to future R.P whilst expenses consumed
completely in one R.P. By recognizing the life is ongoing, we can
recognize that assets will supply some benefit in the future.
Assets  Benefit extends into the future
Expense  Benefit is consumed entirely
3) We can record credit transactions as, we can record an asset
(debtors) or a liability (creditors) as a result of a credit
 transaction as we are likely to either receive cash in the future
or pay out cash in the future.
They do not specifically need to be credit transactions in nature
but must fundamentally involve OWING and being OWED too.
TIP: Going concern Principle essentially gives the firm a future, so
think about the concept of future when discussing going concern
principle.

Historical Cost Principle

Historical Cost Principle: The recording of a transaction at its original
cost or value as this value is verifiable by reference to the source
document.
( Whenever in recording, we use a value, ALWAYS use the original
cost or value from the SOURCE DOCUMENT, as this can be verifiable!
And then key word is free from bias. So in line with the purpose of
accounting this makes our accounting information much more
reliable)
The historical cost principle refers to the idea of verifying our
information, hence as a general accounting principle, we tend to use
the H.C which is verified by our source documents. This is heavily tied
to reliability, KEEP in mind, using the H.C is not always linked to the
H.C principle but whenever it is done to VERIFY info then it is. H.C of
a transaction or item can be – reliable/Historical cost – Relevant –
Conservative etc.
Justification is pretty obvious by now: Ensure information is verified
by source document evidence and hence free from bias
Implication: historical cost is usually preferable to estimates and
should be used when recording.
TIPS: To identify always think about verifiability! Can we verify this
value? How do we verify this value? It must be a source document to
be in line with the HCP and understand the effect of this –
reliable/free from bias
Reporting Period principle
Reporting Period Principle: The life of the business should be divided
into particular periods of time to allow for the construction of
reports and accounting reports should reflect the reporting period in
which a transaction occurs in.
(The business should have reporting period – period of time – and
the date a transaction occurs should reflect the reporting period the
accounting report details)
Essentially, when we communicate our financial information, we
should categorize our reports based on the concept of a “reporting
period”
Reporting period  a period in which a report covers no longer than
a month for ATO taxation purposes.
Justification: The going concern principle states the life of the
business is assumed continuous, hence, it is necessary to divide the
life of the business into periods of time so that reports can be
constructed and profit can be determined.
Accrual Accounting is linked to this principle as it involves recognizing
revenue and expenses in the reporting period in which the revenue is
earned and the expense is incurred or consumed.
Generally speaking, questions to do with profit will link back to this
principle so.
Accrual accounting – reporting period --- profit
We use accrual accounting because cash can be delayed by a lot.
TIP: The reporting period principle can be identified whenever there
is an issue to do with DATES or TIME, when TIME becomes an issue,
it usually links to REPORTING PERIOD. Keep in mind that the TIME of
the transaction to complete and the TIME of the reporting period is
important to keep in mind.
Monetary Unit principle
Monetary Unit Principle: All items must be reported and recorded in
a common unit of measurement.
This principle allows for financial events to be measured, recorded
and reported in “monetary terms”.
Justification: Makes it possible to aggregate total assets and make
comparisons between different reporting periods
Monetary terms  Currency of the country in which the reports are
being prepared, use as a common unit of measurement
We need a common form of monetary unit to be able to compare
businesses
TIP: Identifiable when you look at the idea of COMMON VALUE
SCALES, ask yourself if the scales used to give values are COMMON
and hence can be mathematically aggregated and compared.
Conservatism Principle
Conservatism Principle: Losses should be recorded when probable but gains
only when certain, so that liabilities and expenses are not understated and
assets and revenue are not overstated.
The basic definition states the rules then follows up with the implication of the
rules.
Justification: We adopt a worst case scenario approach to accounting, this is to
be extra cautious and stay on the safe or conservative side when making
estimates or valuations
TIP: Only applicable in the cases of estimations or valuations. Be on the lookout
for cases in which we need to ESTIMATE, give a VALUE to something or DO
NOT KNOW THE OUTCOME.

Consistency Principle
Consistency Principle: Consistent Accounting methods should be applied in a
consistent manner to ensure that reports are comparable between periods.
Examples of ACCOUNTING METHODS – Eg FIFO and Depreciation
Justification: Stay consistent with accounting procedures so that it is a constant
variable in both reports and does not need to be taken into account when
making comparisons.
Without consistent accounting procedures, it is difficult to identify a change in
the accounting reports is as a result of a change in business performance or a
change in accounting procedures.
TIPS: Whenever you see the word DIFFERENT or CHANGE, it is usually an
indication of the consistency principle being breached, just ask yourself, IS
EVERYTHING COMPARABLE BY THE END OF THIS?