The accounting concepts are those rules of accounting which should be followed during basic bookkeeping, and during the preparation of Financial Statements in conjunction with the IASs / IFRSs.
They are very important and all Accountants / Auditors should be aware of these concepts and follow them strictly during the performance of their duties.
The most important concepts are analysed below:
- Separate the legal entity concept: A Company should be treated separately for accounting purposes from its owners, and thus should prepare Financial Statements which include only its own transactions. A Company is also subject to tax on its own merits.
- Accruals / matching concepts: The costs and revenues should be matched one with the other and dealt within the accounting period to which they relate. An example is sales with cost of sales, depreciation on the asset with the revenue generated from the continuing use of the asset etc.
- Going-concern: The Financial Statements should be prepared under the principle that the Company will continue in its operational existence for the foreseeable future and there is no intention or necessity to liquidate or curtail significantly the scale of operations. Foreseeable future means a period of 12 months from the date of approval of Financial Statements from the Board of Directors. If the Financial Statements are not prepared under ‘Going-Concern’, then a relevant disclosure should be made in the Financial Statements.
- Consistency concept: The Company should be consistent in its accounting treatment for similar items within the same accounting period, and from one accounting period to the next. This is important so as to avoid different accounting treatment of similar transactions from one year to the other so as to show a better picture of the Financial Statements, e.g. to change depreciation method from straight line to diminishing balance method.
- Prudence concept: The losses of the Company should be recognised immediately, but the profit / gains should be recognised when they are realised in the form of cash or another asset which is virtually certain that the funds will be finally collected e.g. debtors/losses from onerous contracts should be recognised immediately, but profits from contracts should be recognised in each financial year based on the percentage of completion.
- Substance over concept: The transactions should be accounted for in the books of the Company in accordance with their substance and not their legal effect, e.g. finance lease where even if the lessee is not the owner of the asset it still recognises the asset in its own Financial Statements and the lessor derecognises it.
- Materiality concept: The Financial Statements should disclose separately items which are individually material or unusual. By doing this it enhances the understandability and transparency of those items. It’s not necessary to disclose Immaterial items, and they are reported on an aggregate basis.
- Offsetting concept: Assets, liabilities, income and costs should not be offset in the Financial Statements but they should be reported separately. Offsetting is allowed only if another IAS/IFRS allows it or if it is allowed by law. Generally offsetting is allowed only for items of the same nature i.e. realised foreign exchange gain with realised foreign exchange loss, finance lease interest with finance lease creditor, contra entry between same debtor and creditor etc.
- Comparative information concept: The Financial Statements should always include the results of the company of the preceding period in order to enable the users of the Financial Statements to compare the results of the current period with the preceding one. The comparative information should also be disclosed in the notes of the Financial Statements.
- Frequency of reporting concept: The Company should present a complete set of Financial Statements (including comparative information) at least annually. When the Company extends or shortens the accounting period it should disclose the reason for this action, and the fact that amounts presented in the Financial Statements are not entirely comparable.
The above concepts are part of the IAS 1 “Presentation of Financial Statements” and are very important for the accounting and preparation of Financial Statements. Also, the governmental authorities have, in the majority, adopted these concepts, and they expect that the relevant returns are submitted (VAT and Income Tax) and are in compliance with these concepts.
Please feel free to contact us should you need any additional clarifications and/or explanations.
Olesya Rybkina Chrysanthou ACCA
Managing Director