In: Finance
Briefly describe the following key concepts and principles of
accounting: [80-100 words]
a) Accounting Entity Concept
b) Reliability Principle
c) Going Concern Principle
d) Full Disclosure Principle
a) The accounting entity concept is the principle that financial records are prepared for a distinct entity that is separate from the individuals that own it. It will often be an incorporated company, that is required to be treated as a separate entity by law. In case of partnerships and a sole proprietorship, the accounts reflect transactions of business as an accounting entity and not those of owners of the business. For eg. in a sole proprietorship, if the owner withdraws money from the business in the form of drawings, there are 2 aspects of these transactions. The business is giving money and the owner is receiving money even though there is no difference between the sole trader and the business.
b) The Reliability Principle is an accounting principle that is used as a guideline in deciding which financial information should be presented in the books of the business. It is important that financial statements represent accurate information about the business. It further helps auditors and stakeholder's as the information they want should be clear and reliable. Information can be considered reliable if it can be checked and verified with some evidence. If the information is not reliable, then the business decisions made based on the information will be misleading.
c) The Going Concern Principle states that the business will cease to exist for the foreseeable future. That is the entity won't be liquidated or stop its operations in the future. By making this assumption, the firm can defer the recognition of certain expenses to a later period when the entity will still be in business. It is a very important principle as without it business would not be able to account for prepaid or accrued expenses. If we assume the business may not operate long enough to realize these future expenses, then we would not prepay or accrue anything.
d) Full Disclosure Principle states that the firm is required to disclose necessary information to the public so that they can make better decisions regarding the company. This principle ensures that the readers of the financial statements are not misled by any lack of information. This information can be anything from transactions that have already occurred to future events or expenses anticipated.
Information that should be disclosed include
1) All financial statements (including footnotes)
2) Nature of non-monetary transactions
3) Accounting policies followed
4) Changes made in the accounting system
5) related-party transactions, contingent liabilities, and many more.
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