Accounting Assumptions, Principles & Constraints
Accounting assumptions provide a foundation for the accounting process. There are three major assumptions; the monetary unit, economic entity, and time period assumptions. The fourth assumption is the going concern assumption. The Monetary Unit Assumption makes it mandatory that only transaction data that can be expressed in terms of money be included in the accounting records. The reason for this is so that a company does not put a dollar value on something that cannot be expressed easily, such as the president of a company.
The Economic Entity Assumption states that the activities of an entity be kept separate and distinct from the activities of the owner and of all other economic entities. An example of ...view middle of the document...
Accounting principles area basically a guideline on how to properly record and report economic events. The revenue recognition principle dictates that companies should recognize revenue in the accounting period in which it is earned. In other words, do not record revenues in a timeframe that were not collected until another time frame. The Matching Principle (Expense Recognition) dictates that companies match expenses with revenues in the period in which efforts are made to generate revenues.
The Full Disclosure Principle requires that companies disclose circumstances and events that make a difference to financial statement users. This means that all financial information must be made available to investors to insure the investors are able to make a sound decision.
The Cost Principle dictates that companies record assets at their cost. Accounting constraints are used to modify accepted accounting principles. Materiality relates to an items impact on a firms overall financial condition and operations. If an item will likely influence an investor’s decision, it is material. If the item does not have an influence and the decisions made, it is immaterial. The conservatism constraint is used to simply make sure that you do not overstate assets and income.
Sound financial reporting is extremely important for all parties involved. The company wants to know and understand where their money is and what it is doing, and the same goes for investors. If a company gives an investor the wrong information, or purposefully fails to mention a discrepancy or something of the sorts, and investor can make a poor decision, which could leave both parties upset. In order for companies, investors and creditors to be able to trust the financial statements they are reviewing, there needed be rules and regulations set in place. The placement of the accounting assumptions, principles and constraints was very vital for everyone involved in business.