Interactive worksheet: Accounting concepts and conventions

by Ken Delaney-Moore, Sheffield Hallam University

Aims:

This worksheet deals with:

• The need for objectivity and consistency within the accounting profession.
• The concepts of going concern, accruals, prudence, consistency, cost, materiality, business entity, money measurement, realisation and dual aspect.
• The main provisions of SSAP 2

After having completed the worksheet you should be able to explain these points.

When you are done, please fill-in the on-line evaluation form in order for us to monitor the quality of the materials we provide for you. Tell us what we're doing right and wrong. It takes very little time, and your opinions are valued - thank you.

Introduction

Imagine that you are a business owner, and you take copies of your financial records ('books') to six different accountants. You ask each one to calculate your profit for the year. A fortnight later they each provide you with their answers. There are six different profit figures, with very wide variations between them. What impression do you now have of the accounting profession?

To avoid this kind of situation arising various rules, or accepted ways of going about things have evolved. These rules are known as 'concepts' and 'conventions' (for our purposes there is no effective difference between a concept and a convention, so we shall refer to them as concepts). In addition, it has been necessary to draw - up further rules (known as 'Statements of Standard Accounting Practice' or S.S.A.P.'s, and more recently 'Financial Reporting Standards' or F.R.S.'s).

Together, all of these concepts and statements bring about consistency within the accounting profession, which of course is very important, both for the credibility of the accountants, and for the reliability of the financial results that they report.

In the following exercises it is assumed that you have already had some familiarisation with these concepts and conventions, and with "S.S.A.P.2".

Concepts and conventions

Q1. Complete the following sentences: (Type your answer) accruals - materiality - consistency - business entity - business entity - money measurement - dual aspect - going concern - prudence - cost - prudence - realisation If a firm believes that some of its debtors may "default" it should act on this by making sure that all possible losses are recorded in the books. This is an example of the concept in operation. The fact that a business is separate and distinguishable from its owner is best exemplified by the concept. Everything a firm owns, it also owes out to somebody. This co-incidence is explained by the concept. If a cashier buys a cash book in which to keep his firms books, he would not try to account for every single sheet of paper in the book because of the concept. The concept states that if (say) the straight-line method of depreciation is used in one year, then it should also be used next year. A firm may hold stock which is heavily in demand. Consequently the market value of this stock may be increasing. Normal accounting procedure is to ignore this because of the concept. If we receive an order for goods we would not include the value of it in our sales figures (yet) owing to the concept/convention. A business makes a loss for the second year running, but the concept tells us that it will carry on trading unless we are notified to the contrary. Profit calculation is based on expenses incurred during the period rather than those paid. This statement effectively describes the concept. The management of "DUNFOR plc" are remarkably incompetent, but the firms accountants cannot take this into account when preparing the books because of the concept. The research and development section of "RAKINITIN plc" however is doing so well that they anticipate a huge upturn in sales next year. The accountants cannot increase the book value of the patents held though, because of the concept. The book-keeper for Parker Ceramics would only be concerned with the total value of Parkers drawings, not with how he had spent it because of the concept.

S.S.A.P.2

Q2. Now complete the following sentences relating to S.S.A.P.2: (Type your answer) prudence - accruals - consistency - going concern S.S.A.P.2 identifies four "fundamental" accounting concepts. They are, in (alphabetical order): the concept; the concept; the concept; and the concept.

Q3. Try now to fill-the-gaps in the following, again relating to S.S.A.P.2: (Type your answer) policy - prudence - bases - consistency - concepts The rules that have developed over time and have widely been accepted by the profession are known as accounting . For example, the fact that we should depreciate fixed assets is a direct consequence of applying the concept. There are several different methods by which we can depreciate our fixed assets; these are known as accounting . Once a firm has decided on a particular method (basis), this then becomes an accounting of that firm. The firm should then stick to that policy because of the concept.

Applying the concepts correctly gives a truer picture of profits

Q4. Suppose the first years' profit of Crosspool Bicycles was reported as £25,600. Suppose also that after this figure was reported, it became known that shop equipment with a cost price of £6,000 had been entered in full as an expense. The equipment was estimated to last for five years, after which it would be worthless. Fill the gaps in the following (don't use commas in the figures): (Type your answer) The amount that should have been charged as an expense to this year is £ , giving a corrected profit figure of £ . The relevant concept that should be applied here is the concept.

Q5. The chairman of Aldred Components ltd reports a profit of £78,000 for the year. This includes an amount of £5000 relating to an order just received. Fill the gaps (no commas in the figure): (Type your answer) The real profit is £ because we should apply the concept.

Q6. During the year Rehana Kossar has taken home some clothing stock from her boutique, in order to wear it herself. She has included the cost of this stock (£1,200) as a business expense when calculating the profits as £28,800. Fill the gaps (no commas in the figure): (Type your answer) The concept applies here and the profit figure should be £ .

Now please fill-in the on-line evaluation form in order for us to monitor the quality of the materials we provide for you. Tell us what we're doing right and wrong. It takes very little time, and your opinions are valued - thank you.
You should now be in a position to attempt "Accounting Principles assessment number 2"

Source:
http://www.bized.co.uk