3 Fundamental Accounting Assumptions

After browsing this lesson, you shall be ready to understand the subsequent Fundamental Accounting Assumptions.

  • Going Concern
  • Consistency
  • Accrual

Accounting Assumptions #1


Going Concern

Going concern is that the basic underlying assumption of accounting. Financial statements are prepared to assume that the business may be a going concern i.e. the company intends to continue the business and will be able to do so. In short, it means the business will continue indefinitely.

The business will continue operating and will not close but will realize assets and discharge liabilities within the normal course of operations.

Examples

A nationalized company is in income problems but the govt of the country provided a guarantee to the corporate to assist it out with all payments, the company may be a going concern despite the poor financial position.

An insurance firm is in serious financial troubles and therefore the government isn’t willing to bail it out. The Board of Directors has passed a resolution to liquidate the business. The insurance firm isn’t a going concern.

An oil and gas firm operating in Sudan is stopped by a Sudanese court from carrying out operations in Sudan. The firm isn’t a going concern in Sudan, because it has to shut down.

a producing company features a current ratio below 0.5. A creditor of $1,000,000 demanded payment which the company could not make. The creditor requested the court to liquidate the business and recover his debts and therefore the court grants the order. the corporate is not any longer a going concern.


Accounting Assumptions #2


Consistency

The convention of consistency means accounting practices once adopted must be applied consistently in the future. An accurate presentation and comparison of the monetary position of an enterprise over a period of your time can only be made if the accounting policies so followed are consistent over the years.

But the concept of consistency doesn’t mean the business cannot change to a far better method or presentation, the methods can be changed according to the requirements of the business but the fact of such changes must be disclosed with reason in the financial statements.

Examples

Mr. Y is a garment retail trader. He uses the Last-in-first-out method of inventory valuation in respect of stock at Retail outlet A and the First-in-first-out inventory valuation method in respect of stock at Retail outlet B. In such a situation, if there is no valid reason for the different treatment of the same stock located at different retail outlets, Mr. Y has got to use anybody of the valuation methods consistently for all stock.

Company X has been using the Written down method for charging depreciation on Furniture. By applying the consistency concept the corporate shall still use Written down method of depreciation in respect of Furniture in the following
periods.

In case company X wants to modify to another method of charging depreciation, say line method, it must mention in its financial report, the reason for such change, the nature of the change and the effect of such change, and other similar items


Accounting Assumptions #3


Accrual

According to the accrual concept, a business transaction is recorded as and when it occurs and not when payment for the same is received/made. The sale from any transaction is recorded under this concept i.e. when the sale actually occurs and not when the payment for the same is received; similarly, in case of an expense, the transaction is recorded when the expense is incurred and not when payment for the same is made.

Examples

A Company records its electricity bills when it receives the bills, not when the payment for the same is made, as electricity service has already been provided to the company. In such a case, the corporate has got to ignore the date on which the payment is being made.

A Mumbai-based firm has obtained its premises on rent and has paid Rs 1,20,000 on 1st October. The premises have not been put to use yet so it hasn’t recorded this payment. A half-yearly report is prepared on 31st March, the firm expensed out six months’ rent i.e. 60,000 [Rs 1,20,000/12*6] because time equivalent to 6 months has expired.

Air Asia sells its tickets days or even weeks before the actual flight date, but it does not record the receipts as revenue because the flight being the event on which revenue is based has not occurred to date.


Also, Read Accounting Principles