Question

You have been asked to prepare the final accounts for W Smith, a sole trader, for the year ended 31 December 2013. W Smith has forwarded to you all books of prime entry and ledgers, and in addition, has given you the following information:

i)                Mr Smith had taken £2,000 out of the business bank account to take his wife on holiday.

ii)              Up to last year, the machinery and vehicle used in the business had been depreciated using the reducing balance method. W Smith thinks that they should now be depreciated using the straight-line method.

iii)            Mr Smith is confident, given his order book that the business will continue to operate in its present form for many years.

iv)             Mr Smith had purchased ten staplers, four flip charts and four packets of whiteboard markers which will be used in the business for the next couple of years.

v)               Mr Smith informs you that he has just found an unopened electricity bill for £900 which was for the quarter October to December 2013.

Required

In each case, identify and then explain the main accounting concepts being highlighted and indicate how each should be treated in the final accounts.

Answer 1

I. The accounting concept which is being highlighted here is business entity concept. This concept states that business should be considered as a separate enity.the transactions of business should be treated separately from the personal transactions of its owners. Business has separate existence from its owners .if owner takes money from business for his personal purpose it is treated as drawings and The entry for the transaction will be:

DRAWINGS A/C DR                                                        2000

TO BANK A/C                                                                                             2000

(Being cash withdrawn for personal use)

II. The accounting concept which is being highlighted here consistency concept.this concept states that the accounting policies and assumptions of business should be consistent and making changes in accounting treatment frequently may affect the operations of business.in this case the business man need to change the method of depreciation from reducing balance method, which was being followed by him to straight line method .this is would be violation of the consistency principle.

III. The accounting concept which is being highlighted here is going concern. This concept states that the business will exist for long years and its operations and all its commitments will be fulfilled. And business will continue for long years without liquidation.in this case the business man expects his business to exist for long period of time. The accounting treatment for this case is to value the assets of the business in order to identify their value for continuing their business operations.

IV. The accounting concept highlighted here is materiality concept .this concept states that the financial statement must include all important information’s and material factors regarding the financial transactions .in this case the items purchased by the business man are low cost items and they are treated as expenses instead of treating them as capital expenditure. Actually   it should be treated as capital expenditure but here these items are of low cost and the amount is not material, all these should be treated as expenses in profit and loss account.

V. The accounting concept which is being highlighted here is accrual concept. This concept states that the revenue of the business should be recorded when it is earned by business and the expenses incurred by the business should be recorded when it is incurred. All the revenues and expenses should be recorded in the financial statement in the year in which it was incurred. Here, the business man should record the expense in the year in which the expense was actually incurred.