The accounting process is guided by several notions and fundamental premises known as the basic accounting assumptions. These basic accounting assumptions serve as solid bedrock of the bookkeeping and record keeping tasks of an accountant.
Accounting is a complex discipline. Thus, it’s important that accounting practitioners work with the understanding of the basic accounting assumptions. Needless to say, the basic accounting assumptions enhance the usefulness and effectiveness of financial statements – the end product of the accounting process.
The following is a detailed explanation of each of the five basic accounting assumptions namely accrual basis accounting, going concern assumptions, accounting entity principle, time period concept, and the monetary value/unit principle.
Accrual Basis Accounting
Under the accrual basis accounting, business transactions specifically those relating to income and expenses are recognized and recorded in the books the moment the substance of the transaction has been perfected.
Generally Accepted Accounting Principles (GAAP) prefers that financial statements are based entirely on the accrual basis accounting instead of the cash basis accounting.
In its simplest terms, the accrual basis accounting assumes that income is recognized when earned regardless of the date of payment. On the other hand, expenses are recorded when incurred regardless of whether it was paid in cash or in credit terms.
Going Concern Assumption
Every financial statement reports a business firm’s capacity and performance based on the understanding that the business will continue its operations indefinitely – except if there is evidence that the business firm will close its operations in the near future.
A business firm whose status is going concern reports assets based on their historical value. Similarly, assets carry a book value equivalent to the difference between their historical value and accumulated depreciation.
Under this assumption, market values are ignored as the business firm will continue operating indefinitely.
Accounting Entity Assumption
Basically, the accounting entity assumption is the same as the business entity principle. In this system, a business firm is considered a separate and distinct entity from its owner.
The accounting entity assumption calls for the separation of accounting records between a business firm and its owner.
Time Period Concept
The time period concept holds the idea that business transactions should be recorded when they occur. Recording of business transactions should be done within the course of the business firm’s operating period – either at a fiscal year or a calendar year.
Financial statements are prepared at regular intervals known as accounting periods in order to enhance the comparability within the entity and the usefulness of the financial information contained in the statements.
Monetary Value/Unit Assumption
The monetary value assumption also known as the monetary unit assumption holds that each business transaction is expressed in terms of a common unit of measure – a common currency that has legal tender.
Transactions are expressed in terms of money and it is known to all that an income or expense transaction is to be paid in terms of cash.
John Louie Ramos - JL Ramos is an expert writer based in Manila, PH. He writes for several websites, mostly in the areas of business and personal finance.
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