Find here several of the main accounting concepts – true and fair view, going concern concept, matching and accrual concept, consistency concept, prudence concept.
First of all let’s start from the objective of the financial statements. The main objective is to provide information on the financial position and performance of the business, and also give data on the change in that position during a particular period of time. Such information is provided to a wide range of users and such users make their economic decisions based on such financial data.
What kind of information should be included in the financial statements?
We have already talked about the parts of the financial statements and remembering that these are:
- Assets, Liabilities, Equity – presented on the Balance Sheet
- Revenue and Expenses -presented on the Income Statement
- Changes in Equity, which is not related to Revenue or Expenses – presented on the Statement of Changes in Equity
- Cash Flows – presented on the Statement of Cash Flows
- Additional information provided in the form of notes, which includes other facts which might be important for the users of the financial statements and which is not separately indicated in the Balance Sheet (check for this Balance Sheet Format), Cash Flow Statement, Income Statement (check for this Income Statement Format) or Statement on Changes of Equity.
Complete set of the financial statements includes all the above items.
So when the financial statements are prepared, their preparation is based on the certain basic assumptions or accounting concepts, which will be gradually covered and explored further on this page and other pages.
These accounting concepts are wildly accepted, i.e. these are the basic principles based on which the financial statements are prepared. First one is true and fair presentation or true and fair view. Financial statements should present fairly financial position of the business and its performance, i.e. profit or loss for the period, and also cash flows for the period.
And it is required to have financial statements are compliant with international financial reporting standards and financial/international financial reporting standards which insure that there is a fair presentation. Another assumption is going concerned when we prepare financial statements we assume that the business will continue if operations in the near future.
So we do not say that business will stop its operations. Therefore, all the assumptions and all the figures in the financial statements, they are accounted for and recorded in their way with the assumption that the business will continue to operate and it will not be liquidated or it will not discontinue significant part of its operations in the nearest future.
If this assumption is not correct or if there are any doubts that the business will not be operating in the nearest future such information it must be disclosed in the financial statements so the user software financial statements they must know that the business intends to discontinue its operations or a significant part of operations or a significant part of operations.
In our assumption also very important, it is accrual or matching principle. While preparing financial statements we must follow accrual principle or matching principle these are the same. They talk about the same aspects and this means that we should recognize assets, liabilities, equity, income or expenses when they satisfy a certain definition and recognition of criteria.
This means that we recognize for example the revenue when we earn that revenue despite that cash will be received later. Also we recognize liabilities when there is a liability so when the business is obliged to pay money to the creditors. So this is accrual principle and these are the examples of that principle.
And number 2 assumptions which are also important is consistency, concept which means that presentation and classification of the items in the financial statement must be consistent and from one period of time continuing to the other periods of time we must apply the same principle and the same rules in the presentation and classify the items in the same manner.
And if we change the principles of classification there must be explanation by we do that and that explanation must be supported and reasonable so we need to disclose and explain to the users of a financial statements why we have changed classification and presentation rules comparing to the previous periods.
Another assumption is prudence. This is means that while preparing financial statements we need to be cautious so we need to make estimates and we need to be prudent so we do not aim to overstate value of assets or understate the value of liabilities. So this is the meaning, this is required for the users of the financial statements since they do not want to see all the stated value of assets on the stated value of liabilities.
For gross profit calculation check Gross Profit Formula – Gross Profit Margin Calculator, use for this Income Statement.
So they need to have a fair presentation of value of those items. In the next video we will continue with the other important assumptions for the preparation of the financial statements.