Accounting Principle
Definition:
Monetary Unit Assumption is the accounting principle that concern about the valuation of transactions or event that entity records in its financial statements.
In Monetary Unit Assumption, transactions or event could be recorded in the Financial Statements only if they could measure in the monetary term where those currencies are stable and reliable. USD is the main example of a stable currency.
If you ever read the financial statements of an entity, you will note that all the transactions and event in the financial statements are records and present in the monetary term for example USD or other currency.
The following is the detail explanation of the monetary unit assumption.
Explanation:
For example, the inventories that the company purchased for resales have their own values and can be measured in currency, USD. These kinds of inventories could be recorded in the Financial Statements.
However, the staff’s skill could not record in the financial statements as assets. And staff turnover cannot record as the lost or liabilities. Staff de-motivation will turn out to be the cost of the company.
But, we can not measures and records this de-motivation cost in Financial Statements.
Based on Monetary Unit Assumption, you cannot measure and records beautiful customer service staff in Financial Statements, but you can record telling machine based on its value even though customer staff benefit to the company better than telling machine.
The currencies that use to measure the transaction or event in the financial statements normally are stable and internationally recognized. For example, USD is the currency that internationally recognize and quite stable.
The entity could measure the transactions and event in its own country currency if that currency is stable and internationally recognized.
Example of Monetary Unit Assumption:
In general, most of the financial statements are present in USD as it is the most effective way to communicate economic activities. Whenever there is inflation or deflation, the accounting transaction could be changed and they are ignoring.
Noted: When there is inflation, the value of assets and liabilities are not change in the Financial Statements based on Monetary Unit Assumption. However, assets are impaired if carrying value is less than fair value.
For example, in 2015, the entity purchased fixed assets value 5,000 USD and then in 2016, there is inflation.
The fixed assets then require 6,000 USD to purchase. In this case, the fixes assets valuation in the financial statements could not change. However, if the entity wants to change the value of assets in the financial statements.
The entity needs to perform fixed assets revaluation for all of the fixed assets in the entity. This revaluation could not base on the selection of fixed assets.
The buildings that have original cost USD 20,000,000 can not be changed to USD 50,000,000 due to increasing of current material and labour and well as the effect of inflation and time value of money. But they could be revalued and present in the Financial Statement.
Conclusion:
Monetary Unit Assumption:
- The transaction and even that can measure in currency, Example.
- Can not record the transaction that could not measure in currency.
- The dollar is the most effective way to communicate economic activities.
- Only transaction that can express in the monetary term that can record in financial statements.
- Inflation and deflation are ignored in accounting records.
- Money is universal, understandable, comprehensible, and the simplest way to convey financial activities.
Hope you find this article importance and if you have any comment, please leave it below.
Written by Sinra
Accounting Principle
Overview
Materiality Principle or materiality concept is the accounting principle that concern about the relevance of information, and the size and nature of transactions that report in the financial statements.
The main objective of the materiality principle is to provide guidance for the accountant to prepare the entity’s financial statements.
And the most important thing is to make sure that information using by shareholders and investors is sufficient enough for them in making the correct decision.
The information, size, and nature of transactions are considered material if the omission or error of it could potentially lead to the decision of users of financial information.
The materiality concept is not only used by the accountant as the basis to prepare the entity’s financial statements but also used by auditors to assess the correctness of financial statements’ disclosure and use in their audit testing.
Normally, the auditor determines what is the performance materiality and what is the tolerable error for their testing.
There are some differences from one accounting standard to another accounting standard. For example, in IFRS, information is material if the omission could lead to misleading in decision making.
And the filter of materiality hand to management for decision making. IFRS is a kind of principle base accounting standard. Therefore, many shareholders and investors find it difficult in dealing with materiality.
In US GAAP, for example, items should be separately disclosed in the financial statements if they have value over 5% of total assets. This is also the same the security and exchange in the US and it is used to apply to the items in the balance sheet.
But, for items in income statements, items that could affect the net income from positive to negative are also considered as material items even they are small.
Basically, materiality applies in US GAAP sound easy and helpful for shareholders and investors that IFRS. Because in US GAAP if the transaction meets the requirement, then the accountant must be complying with it.
But in IFRS, the accountant still could disclose the transactions with others even the value is high enough to disclose alone. If they could interpret that it will not misleading.
In general, in the materiality principle, the size, information, and nature of the transaction are considering as materiality is different from one entity to another entity. The difference is mainly because of the size of the entity.
Conclusion:
The materiality Principle is not only protected the shareholder’s and investors’ interest but also help to account for preparing its Financial Statements.
Base on this principle, the account could know what is material and what is immaterial. They also know what should be separately disclosed and what should be included with other transactions.
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Written by Sinra
Accounting Principle
Definition:
Full Disclosure Principle is the accounting principle that requires an entity to disclose all necessary information in its financial statements and other related signification.
This is to ensure that the users of financial information are not misled by the lack of information. The idea behind the Full Disclosure Principle is that management might try not to disclose any information that could impair the entity’s financial statements as well as its reputation as a whole.
In doing so, the financial statements still look good and healthy so that all of the stakeholders still happy about the company.
Full Disclosure Principle requires the entity to disclose both, Financial Related Information and No Financial Information Related to the company.
This kind of non-financial information including major changed in the business, contracts, related parties transactions, and any other significant information.
Example of Full Disclosure:
The entity might lose large contracts with its customers to its competitor. And the subsequent loss of contract could turn the entity into bankruptcy. In such a case, management probably doesn’t want outsiders, especially investors to know the real situation of an entity.
And base on the Full Disclosure Principle, the entity is required to disclose such a situation in its financial statements.
Another example is related to the full disclosure of contingency. It can be contingent assets or contingent liabilities. For example, the company is facing the lawsuit as the result of disposing poison material into the water and it going to be a large penalty.
Based on the Full Disclosure Principle, the entity required to fully disclose this information in its Financial Statements. Once the users of Financial Statements noted this information, they will understand what are the current contingent liabilities of the entity.
Related: Best know Accounting Principle
But, how do we know if the entity complies with the Full Disclosure Principle?
Well, basically, to ensure that whether the entity complies with the Full Disclosure Principle or not, the entity should go to the standard that they are following. Remember, Full Disclosure is just the principle to help entity especially accountant in prepare and present financial statements.
In practice, you are highly recommended to see the specific requirement of each accounting standard. For example, in IFRS, each standard has the requirement of disclosing accounting transactions or even that entity deal with and do so US GAAP.
Different accounting standard has different requirement of disclosure. IFRS is the kind of principle base and the requirement still based on the judgment of the practitioner. However, US GAAP is the role base where the disclosures are the must.
If your Financial Statements us IFRS, IAS 1 Presentation of Financial Statement should be applied. Here is the general disclosure that the financial statements of an entity are required to have.
Full Disclosure Principle Check List:
- Full Financial Statements. Generally, Statement of Financial Position, Income Statements, Statement of Change in Equity, Statements of Cash Flow and Noted to Financial Statements
- Significant Accounting Policies: State the basis and accounting policies of each significant accounting policies. For example, Revenue Recognition, Depreciation, Asset Measurement and Recognition…etc
- Accounting Standard use to prepare financial statements. For example, IFRS, US GAAP or other local GAAP.
- Nature of business
- The significant event happens in the business
- Going Concern Assumption
- Changes in accounting estimates
Full Disclosure Principle simply mean disclose all information that requires by an accounting standard, and the best way to check this is going to the specific standard.
Related book: Accounting Principles
This book is punished by three co-authors and by Jerry J. Weygandt, Paul D. Kimmel, and Donald E. Kieso (Author) and written review by 176 customers.
By Sinra
Accounting Principle
Definition:
Consistency principle is the accounting principle that requires an entity to apply the same accounting methods, policies, and standards for preparing and reporting its financial statements.
The main objective of the consistency principle is to avoid any intention from management using an inconsistency approach to manipulate the financial information to ensure their financial statements look healthy.
And sometime, management could use the inconstancy principle on the same accounting transactions or accounting even in their financial records. It is the hug risk to the user of financial statements if they are not fairly present.
IFRS also requires the entity to apply the same accounting policies in reporting its financial statements. In case there is any change in accounting policies and estimates, IAS 8 should be used.
In addition, this concept, consistency principle, also quite important for users of financial statements, investors, and shareholders.
As long as the financial statements are consistently use accounting policies and principles, the financial statements will be more accurate and reliable.
The correctness of decision making highly depends on the accuracy of financial information.
Why is the accounting principle inconsistency?
There are many cases that caused the entity to apply inconsistency accounting principles or policies. For example, there is a requirement to change accounting policies by the standard setter.
There is a requirement from the regulator of those jurisdictions and also the requirement from the entity itself.
All of these things cause the entity to apply the inconsistency principle. And the solution is the find the guideline on how to deal with it.
Different accounting standards probably use different guidelines. For example, if the financial statements use IFRS. The Consistency Principle that you should follow is IAS 8.
Example of the consistency principle:
For example,
Company A’s Financial Statements report base on IFRS. Its accounting policies for depreciation is using a straight-line basis. In 2014 and 2015, it uses a straight line.
But, the company subsequently wants to change its accounting policies from a straight line to a declining balance.
In this case, the entity should apply with IAS 8 whether it is the retrospective or prospective change. All of the change requires full disclosure in the financial statements and how the change affected. This is how we apply the Consistency Principle.
Sometimes, management’s performance is based on Net Sales or Net Profit and the way how management not complying the Consistency Principle in their Financial Statements also based on this.
For example, if the performance is base on Net Sales, management might not recognize revenues by using the same accounting policies.
And if management performance is base on Net Profit, management might play around with operating expenses to ensure that net profit looks favorable. For example, through depreciation, accrual and other expenses.
If you have any comments related to the Consistency Principle, please drop it here or create a new topic in our forum.
Written by Sinra
Accounting Principle
Definition:
Conservatism principle is the accounting principle that concern about the reliability of Financial Statements of an entity. The conservatism principle provides guidance to accountants on how to records and recognizes the uncertainty outcome of revenues, expenses, assets, and liabilities in financial statements.
This principle also intends to ensure that the users who use financial statements receive enough and reliable information as they should be.
Under the conservatism principle, assets and revenue could be recorded or recognize unless it is clear that the entity could measure those transactions reliably. In addition, the expenses and liabilities are records at the highest value where assets and revenues are records at the lowest value.
This principle could help to minimize the entity to overstate the revenue and assets and understate the liabilities and expenses in its financial statements.
For example, without using this concept, the accountant could manipulate the accounting records where those transactions are not reliable.
Then, the financial statements result unreliable. Subsequently, there is an effect on the users of Financial Statements.
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In real life, smart CFO and CEO might play some tricks on how to ensure that Financial Statements of the company look healthy while the reality doesn’t.
Over recognition of revenues and assets, and negligently relay to recognize liabilities are the basic place to start.
Example of Conservatism Principle:
For example, the entity should recognize the liabilities that claim to the employee for the legal case even the entity not sure if they are failing. And the recognition should be at the highest value.
But, the entity should recognize assets for legal claims from an employee unless there is a clear statement from the court.
And if assets are recognized, it should be at the lowest value. In this case, it is helping users of FS to understand all types of liabilities and expenses that probably happen to the entity. And, it assures that the revenues recorded are realistic.
Conservatism principle assumes the entity could possibly try to overstate assets and revenues, and understate expenses and liabilities.
For recognition revenue, conservatism principle, the entity could recognize the revenue if the revenue transaction could not measure reliably and the outcome of those transactions are unpredictable.
Conclusion:
This concept seems difficult, but it is quite straight forward. Here is the summary of principle:
- Assets and Revenue are recognized at the lowest value and unless we can measure it is reliably
- Expenses and Liabilities as soon as possible when there is uncertainty
In case, you found Conservatism Principle difficult. I give you one statement and hope it helps.
The same to in real life, you recognize bad news first, and for goods news, wait until it come true.
Feel free to leave a comment here.
Written by Sinra
Accounting Principle
The business entity concept or business entity principle considers the owner of an entity has different legal liabilities from the entity’s obligations.
Under this concept, the entity must records all transactions separately from that transaction that belongs to its owner. If it is recording, the substance of the transactions or balance should clearly be defined.
For example, the owner of an entity withdraws money from the entity for use in personnel matters. In such a situation, the accounting record must clearly state these transactions in the entity’s financial statements.
Income that personally earns by the owner should also record separately from the income that generates by the entity.
From the accounting point of view, using a business entity concept, owner assets, liabilities, income and expenses as well as equity are considered separately from his/her entity. For example, if the owner of the entity borrows money from the bank.
The debt belongs to the owner, not the entity. And, if the entity borrows money or purchase goods on credit, then the debt is belonging to the entity. Not the owner.
Tax Responsibilities:
There are many reasons why financial statements should be prepared base on the Business Entity Concept. From the tax perspective, the owner and entity have different tax rights and responsibilities.
The entity is not responsible for paying the tax instead of its owner, and the owner is also not bear any responsibilities for its entity.
Well, sometimes it also depends on the type of entity that it is registered in. Partnership, limited liabilities, or else. But, in general, the owner and entities have different tax liabilities.
Because of these different liabilities, accounting information must be separately recorded, taxes are separately submitted.
They have different legal responsibilities. The owner owns the bank if they borrow, not the entity. If the money is not paid back, bank sue owner, not entity
Legal Responsibilities:
When the company liquidates, creditors, bankers, and other parties could have the right to enforce the company to pay the debt. But they can’t enforce the owner to pay the debt on behalf of the entity.
Again, this also depends on the type of regal entity that the company register in and how it is interpreted according to the local law.
In general, the owner and entity have different legal liabilities and having separate records of assets and liabilities are required by most of the local law as well as accounting standard.
The benefit is when there are legal or financial problems with both the entity or its owner.
Importance:
The business entity concept is one of the account principles that are really important to the stakeholders and the key users of financial statements.
For example, by taking this principle into account when analyzing and recording financial statements, the users could assure that the information contains in the statements was related only to the business. They are not mixed up with the owners of the company.
Or if the transactions between owners and the entity have occurred, then the treatments were transparently taken between owner and entity.
It is also really important for banks and other lenders when the entity submits the financial statements to the banks or lenders as part of the loan’s requirement and the bank/lender could use the information to assess the entity’s financial position and performance confidently.
Banks/lenders could assure that financial information is only related to the entity’s business.
Sinra
