Question

Ms. Sandipa is the accounts executive for a company called SS Enterprises. Her job description requires her to supervise the process of recording of the transactions of business and to ensure that all accounting assumptions are taken care of. However, her junior executive is confused about the concepts of the accounting period assumption and the Separate entity assumption.

Elaborate on how Sandipa can explain the concepts to her junior with the help of a suitable example.

The above question contains 20 Marks. As per University guidelines, the answer should be a min of 800 words. If possible then only prepare. If you provide 400 / 500 words its not useful for me. Pls ensure need a min of 800 words answer.

Answer 1

ACCOUNTING PERIOD ASSUMPTION

-Under this concept, the economic life of a business is divided into smaller sub parts, known as periods. It is also known as Periodicity principle.
-This period practically consists of a time frame of one year. This period can either be a:

• Financial year, which begins from 1st April and ends on 31st March or
• Calendar year, which begins from 1st Jan and ends on 31st December.

-For internal reporting purposes, the period can range from a month, quarter, six month period etc.

Need of Accounting period assumption:
-The Financial Statements of the business, that is, The Income Statement, which shows the profit and loss for the period and the Balance Sheet/ Position Statement, which tells about the worth of assets and liabilities possessed by a business at the end of the period, are both made taking the Accounting period concept into consideration.
-Also, because of the Accounting period concept that should be in line with the Matching concept, there is a need for adjustments that apportion the part related to the current period in the Statement of Profit and Loss and the balance needs to be shown in the Balance Sheet.
-Thus, for calculating the true position as well the results from operation for a particular period, Accounting period assumption is followed, otherwise, interpretation of results for a period would not be possible.

• Also in the first year when the business commences its operation, the accounting period can be less than one year. For example, take the Calender year that begins on 1st Jan,2020 and ends on 31st Dec, 2020. Mr.X started a new business on 1st April, 2020. Thus, the Accounting period from him will be less than one year i.e a nine month period, that will begin on 1st April, 2020 and end on 31st December, 2020. Thereafter, the periods will be from 1st Jan of every year to 31st December of that year.

• Similarly, in the year when the business gets wound up, that is, the last year of operations of a business, the accounting period can be of a shorter time frame. Consider the same example as above. Now, Mr. X winds up his business on 30th November, 2029. Therefore, the accounting period will be from 1st Jan, 2029 to 30th November, 2029, i.e. a period of eleven months.

-The Accounting Period concept also facilitates comparison between the current period and the respective previous periods. If this concept wouldn’t exist, there could be no trend analysis possible because the period would vary, leading to wrong interpretations and conclusions.

SEPARATE ENTITY ASSUMPTION

-According to this assumption, the transactions of the business are distinguished from that of its owner(s).
-This assumption makes sure that, though the business belongs to the owner(s), the business transactions and personal transactions are differentiated in order to arrive at the correct result of the operations and the financial position of business.
-Thus, a Business is considered to be a separate legal identity, distinct from its owner(s).

Need of Separate Entity Assumption:
-If this assumption is not followed, then the Financial results as well as the Financial position will be calculated wrongly, leading to a violation of True and Fair principle.
-There will be an error in the profit and loss calculated, which is actually a result of the business operations.
-It is just because of this assumption, that the concept of drawings prevail, which is the amount/resources that are withdrawn by the owner for personal use, leading to a decrease in owner’s capital.

• For example, if the household expenditure of $300 of owner is wrongly treated as business expenditure, the profits of the business will be understated by the amount of the expenditure incurred i.e. $300. Whereas, the expenditure of $300 does not relate to business so it can not be treated as expense in the books of account of the Business enterprise. It should be treated as Drawings.
  
• Similarly, if cash is withdrawn by the owner to purchase a personal vehicle for $10,000 and if that vehicle is shown as an asset in the balance sheet of the business, this will lead to a wrong result because the vehicle is not being used for business purpose. Further, if this personal vehicle is wrongly treated as asset of business, then depreciation will also be charged against revenue of the business, which will decrease the net profit of the business. Again, reduction in net profit due to depreciation on personal vehicle is wrong, as the vehicle has not been used for business. This issue can be easily resolved by treating cash withdrawn by owner for purchase of his personal vehicle as drawings. Thus, in the given case, drawing accounts will be debited and cash account will be credited.

Thus, both these assumptions i.e. Accounting Period and Separate Entity are of utmost importance, as a violation of these concepts will falsify the Financial results as well as the Financial position of business.