Question

 

Four fundamental concepts of accounting are eentity concept, going concern concept, unit of measure concept, and periodic reporting concept.

Required:

a. Explain each of the four concepts in relation to financial reporting of a company.

b. Discuss how the compliance of each concept is necessary in enhancing the quality of corporate financial reporting.

Answer 1

• Accounting entity assumption: The accounting entity assumption states that the business is an entity (perceived to have its own existence) that is separate from its owner. Without this assumption, the financial affairs of the owner would be included in the business reports distorting the real financial performance and position of the business. It is also the key assumption that underpins all transaction recording by the business. i.e all transactions are recorded from the point of view of the business.
• Going concern concept: Accountants assume that a business will continue to operate for an indefinite period of time or at least into the foreseeable future. Without this assumption many current assets would need to be valued at liquidation prices or expensed and the cost of fixed assets could not be spread (depreciated) over the fixed asset's useful life. Again not providing a 'true and fair' view of the business.
• Monetary measurement assumption: Accountants do not account for items unless they can be quantified in monetary terms (that is, money was exchanged to acquire the item or a market exists that would be prepared to exchange money for it). Without this assumption, accountants would be free to subjectively value and add to reports resources like workforce skills, business morale, market leadership, brand recognition, quality of management. While these resources do have market value, it is left to the stakeholders not the accountant, to determine the subjective value for themselves.
• Time period convention: This convention allows for the performance evaluation of a going concern business to be broken up into specific periods of time such as a month, a quarter or a year. Without this convention, stakeholders would not be given timely and comparative reports on the financial performance and position of the business and so robbing them of the opportunity to adjust strategies relating to the resources under their control.