Accounting Conceptual Framework

Accounting Conceptual Framework

Generally Accepted Accounting Principles

The entity concept (business – entity concept). Under the business entity concept, for accounting purposes, every business is conceived to be and is treated as a separate entity, separate and distinct from its owner or owners and from every other business. Businesses are so conceived and treated because, in as far as a specific business is concerned, the purpose of accounting is to record its financial position and profitability. Consequently, the records and periodically report its financial position and should not include either the transactions or assets of another business or the personal assets and transactions of its owner or owners. To include either distorts the financial position and profitability of the business. For example, the personally owed automobile of a business owner should not be included among the assets of the owner's business. Likewise, its gas, oil and repairs should not be treated as an expense of the business, for to do so distort the reported financial position and profitability of the business.

It should be also made a clear distinction between accounting and legal entities. In some cases the two coincide. For example, corporations, trusts and governmental agencies are both accounting and legal entities.

The proprietorship is an accounting entity, as indicated by the fact that all assets and liabilities of the business unit are included in its financial statements. The business proprietorship is not a legal entity (is not legally separated from its proprietor). He is legally liable both for his personal obligations and for those incurred in his business. For accounting purposes, the proprietor as an individual and his business enterprise are separate entities. A corporation is a legal entity (the shareholders are not responsible from the legal point of view for the company's debts or obligation), separate from the persons who own it.

As a general rule, we may say that any legal or economic unit which controls economic resources and is accountable for those resources is an accounting entity.

The going – concern assumption (continuity of activity convention). An underlying assumption in accounting is that an accounting entity will continue in operation for a period of time sufficient to carry out its existing commitments.

The assumption of continuity leads to the concept of the going – concern. In general, the going concern assumption justifies ignoring immediate liquidating values in presenting assets and liabilities in the balance sheet. The going – concern principle assumes an indefinite life for most accounting entities.

Accrual convention (the independence of financial year principle). This principle states that any transaction should be registrated in the moment when it happens and not in the moment of paying or receiving the money.

For example, a company sells merchandises in its total value of $400, on January, the 2nd 2002 and will receive the money later on a certain maturity date, which is March, 3rd 2003. The accrual convention says that the company should registrate the transaction in the moment it was generated (on January, the 2nd 2002) and not in the moment it will receive the money (Accounts Receivable) which is March, 3rd 2003.

Consistency. The same procedures used to collect accounting information should be used each fiscal period; in the absence of this standard it is not possible to make decisions and comparisons.

Periodicity (the time period principle). Statements of the operation's financial condition must be reported periodically. So, this principle assures the requirement to measure operating progress and changes in economic position at relatively short time intervals during the indefinite life of the business entity. The intervals are called "accounting period of time" or just "accounting year".

In each accounting period (usually a year, but the reports may be made quarterly or even often) it is necessary to present the beginning financial position (though the beginning balance sheet) and a final financial position (determined at the end of the period) though the ended balance sheet.

Dividing the life of the enterprise into time segments and measuring changes in financial position for these short periods is a difficult process. The tentative nature of periodic measurements of net income should be understood by those who rely on periodic accounting information. The need for frequent measurements creates many of the accounting most serious problems.

The most common reporting is the financial year, which in our country and in Europe could be the same with the calendaristic year (Jan 1st – Dec 31st) and in UK lasts from April the 1st to March 31st .

Prudence (conservatism). This standard requires that all losses are to be shown in financial records if there is a reasonable change that such problems will occur; gains and related financial benefits, however should not be reflected in records until really occur. Further on, in accounting will registrate elements for the minimum value between book value and inventory value.

This principle is important since many accounting decisions do not have a single “right” answer. Therefore, a choise between alternative assumptions is necessary. This concept guides the accountant faced with alternate measurement to select the option with the least favorable impact upon the net income and financial position within the current accounting period.