Accounting Concepts Used in Preparation of Financial Statements

This report explains six accounting concepts used in the preparation of financial statements including money measurement, historic cost, going concern, business entity, dual aspect, and realization concepts. These concepts ensure uniformity in the preparation and maintenance of financial statements and assist accountants with recording business transactions.

Accounting concepts

Table of Contents
INTRODUCTION...........................................................................................................................3
MAIN BODY..................................................................................................................................3
Accounting concepts used in preparation of financial statements...............................................3
CONCLUSION................................................................................................................................5
REFERENCES................................................................................................................................1

INTRODUCTION
Accounting concepts are the set of rules, conditions and assumptions that explains the
factors and controls following which accounting functions. These concepts ensure uniformity in
the preparation and maintenance of financial statements. Accounting concepts are useful in
assisting the accountants with recording of business transactions. This report will explain six
accounting concepts that are used in the preparation of accounting statements.
MAIN BODY
Accounting concepts used in preparation of financial statements
Money Measurement Concept: According to the accounting concept of money
measurement only those transactions that can be expressed in the monetary terms are recorded in
the books of accounts. As per this concept it is assumed that all transactions of a business entity
can be expressed in the financial terms (Aboutorabi and et.al., 2022). This concept also
represents the limitation of accounting that non-financial transactions cannot be accounted
during accounting for an organization. For instance, the transactions like purchase of raw
materials worth £20000, a sale of £5000, rent of £2500 paid, £10000 received from debtors, etc.
are all transactions that are capable of being expressed in money terms and hence can be
recorded in the books of concerned party. But transactions like increasing loyal of employees,
enhancement in the work culture of the organization, etc. are the transactions that cannot be
represented in money terms for their recording.
Historic cost concept: The historic cost concept of accounting states that all the assets
that belong to an organization are recorded at their historic cost, that is their purchase price or the
price at which the firm acquired the assets (Accounting Concepts Used for the Preparation of
Financial Statements, 2021). Recording of assets at their current price is argued to give more fair
and accurate picture of the financial position of the company but there are various limitations
associated with it, so it is recommended to record the assets at the historic price for avoiding
limitations. For example, ABC limited, a cloth manufacturing company purchase a machinery
for £500,000. £2320 spent on the transportation of the machine and £1525 were spent by the
company on the installation of the asset. So the amount that will be recorded in the books of
accounts for the machinery will be £500,000 + £2320 + £1525 = £503,845, that is the total cost
company paid for the machine. This is called the historic cost of the asset. Original cost of an
asset is the historic cost less the depreciation amount (Bailey and Samuels, 2018). This concept

implies that if the firm has not paid anything during the acquisition of an asset, the asset will not
be recorded in the books of account. That is why only purchased goodwill is recorded in the
books of accounts.
Going Concern Concept: Another concept of accounting that is followed during the
preparation of financial statements is going concern concept. It is assumed that the business is
running with the assumption of timeframe as indefinite and there is no will to shut down the
operations in near future (Granof, Khumawala and Calabrese, 2021). This can be explained with
an example for better understanding of the concept. Suppose a company purchased a machinery
by paying £6,000,000 with an expected life duration of 20 years. Following the concept of going
concern, the business is assumed to continue operating all these years and hence the amount is
not charged from the revenue of the year in which the asset is being acquired in whole. Instead
only the part of asset consumed in that year is recorded as expense and the balance amount is
recorded in the balance sheet as asset.
Business Entity Concept: As per this accounting concept of business entity both the
business and the owner/s of the two distinct entities. This means that the transactions of the
business and the personal transactions of the owner/s are separate and not the same. Whenever
the capital is brought by the owner in the business it is treated as the liability for the business and
drawings of cash from the business is not treated as expense to it. The transactions are recorded
in the books from the perspective of business and not the owner of the business. For instance, Mr
A started a business with £100,000 being invested by him. Further he bought plant and
machinery for £5,000,000, furniture for £200,000, and cash in hand £10000. These assets will be
considered as the assets of business and not personal assets of Mr. A. Only the capital invested
will be treated as liability for business towards the owner. Further the cash or goods taken by Mr.
A will be recorded as cash/ goods withdrawn by owner.
Dual Aspect Concept: This concept is the basic principle of accounting. It states that
every transaction has a dual effect. While recording the transactions of business in books each of
the transaction effects two accounts. This concept is expressed by an equation Assets =
Liabilities + Capital, this is known as accounting equation (Wiedenhofer and et.al., 2019). For
example: purchase of goods have dual aspect first decrease in cash and second receiving of
goods. Both the aspects are recorded.

Realization Concept: another accounting concept followed in preparation of financial
statements is realization concept. It states that revenue that generates from any business
transaction is recorded in the books only when it is realized. Realization is a term used to refer to
the creation of rights for receiving of money legally. Revenue is considered to be realized only
when the money gets received or the right to receive money creates. For instance, a jewellery
shop received an order for supply of ornaments worth £6,500,000. For the year ended 31st March
2021 ornaments worth £3,500,000 supplied to the customer. In the books of accounts only
£3,500,000 will be recorded as revenue for the year 2021 as only receiving of order is not
considered as revenue realisation.
CONCLUSION
Based on the above report it can be concluded that accounting concepts are vital for
recording business transactions. The report has discussed various accounting concepts like
historic cost, going concern concept.

REFERENCES
Books and Journals
Aboutorabi, H. R. and et.al., 2022. Using water footprint accounting concepts to determine the
optimal cropping pattern of rainfed farmlands (Case study: Ghaenat and Zirkuh
counties). JOURNAL OF AGRICULTURAL SCIENCE AND SUSTAINABLE
PRODUCTION. 32(1). pp.187-201.
Bailey, W. J. and Samuels, J. A., 2018. Analyzing Two Investments—An Instructional Case to
Introduce Basic Financial Accounting Concepts. Issues in Accounting Education
Teaching Notes. 33(4). pp.18-29.
Granof, M. H., Khumawala, S. B. and Calabrese, T. D., 2021. Government and not-for-profit
accounting: Concepts and practices. John Wiley & Sons.
Wiedenhofer, D. and et.al., 2019. Integrating material stock dynamics into economy-wide
material flow accounting: concepts, modelling, and global application for 1900–
2050. Ecological economics. 156. pp.121-133.
Online
Accounting Concepts Used for the Preparation of Financial Statements. 2021. [Online].
Available through: <https://www.mbaknol.com/business-finance/accounting-concepts-
used-for-the-preparation-of-financial-statements/>
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