PRINCIPLES OF

ACCOUNTING 1
 WHAT DO YOU UNDERSTAND BY
PRINCIPLES?

– MAIN BELIEF – PHILOSOPHY

– CODE – DOCTRINE
– RULES – FUNDEMENTALS
– REGULATIONS – STANDARDS
 WHAT IS ACCOUNTING

TO ACCOUNT (VERB)
1. Consider or regard in a specified way.

2. Prepare or present a record an account

of money given or received.
 WHAT IS ACCOUNTING

ACCOUNT AS A WORD / VOCABULARY

– a record or statement of financial

expenditure and receipts relating to a
particular period or purpose.
 INTRODUCTION

– One may dream of running his or her business. Where

does he or she begin? How much money does it
make? How will he or she measure success or failure?
To answer all those such questions and other related
to those questions the investor must have accounting
system updated to give the fundamental elements
useful to the decision making.
Accounting is the information system that
measures business activity, processes the
data into reports, and communicates the
resultants to decision makers.

Accounting is a language of business. The

better you understand the language, the
better you can manage the business.
 CHAPITER1:
ACCOUNTING AND
THE BUSINESS
ENVIRONMENT
1.1 OBJECTIVES AND DEFINITION
OF ACCOUNTING
 WHAT IS ACCOUNTING THEN?
Definition One
– Accounting is defined by the American institute of
certified public accountants (AICPA), terminology
committee as follows: “the art of recording,
classifying and summarizing in a significant manner
and in terms of money transactions and events
which are in part at least of financial character and
interpreting the results thereof …”.
If we analyze this definition, we can say that:

Art of accounting: this helps managers at different levels to know how

much their companies have in terms of assets of business, liabilities,
and profit or loss earned.

Of recording: every item entered in the books of accounts must be

reordered in terms of money.

Of Classifying: all transactions are recorded in a classified manner and

in their special books or accounts.

Of Summarizing: at the end of every year the accounting must prepare

the business’ situation to be presented to different users of financial
information. By doing this, the accounting helps the business founders
or owns to know the business performance.
Of financial character: whatever is not directly of financial
character will not be found in the books of accounting.

Interpreting the results thereof: the rules and regulations of

accounting provide that all the transactions within the
organization or company have to be prepared based on IFRS
and used in their interpretation in financial statement.

It is therefore a service activity meant to provide quantitative

information about economic entities (Businesses). Its
information is primarily financial in nature and is intended to
be useful in making economic decisions. Economic entities
include hospitals, schools, cities, governmental agencies,
private non-profit oriented and profit-oriented businesses.
The true purpose of accounting is to
maintain proper control of finances of a
business. This is achieved by:

(i) Accurate recording of data

(ii) Classifying the summarized data
(iii) Analyzing and interpreting the classified
data
(iv) Communicating what has been learned
to interested parties.
 Defintion 2
Generally, the accounting is defined as technique or
system that consists of identification, recording, classifying,
summarizing and communicating the financial transactions
occurred in the company.

a. Identification: in this stage accounting provides the

identification of all economic activity or operations occurred
in a given company during the whole accounting period.
b. Recording: under this stage accounting analyzes and
records chronologically all the transactions occurred within
the organization. This task is done by using the accounting
journal.
c. Classification:in classification all transactions recorded
d. Summarizing: all the transactions occurred in the accounting of
any entity can not be presented in the nature they occurred, they
have to be summarized so that the users of financial information
may know that happened in a proper way without reading
transaction by transaction. So the summary is mostly presented into
financial reports which give the summary of those transactions
occurred in the company in a given period.

e. Communication: the accounting serves a lot in communicating

the business’ situation or state to different users of its information
and helps managers to take relevant and viable decision on time. So
the financial reports must be legally valid. The profession of
accounting provides the nature of those reports in terms of financial
statements and they are: balance sheet, income statement,
statement of cash flows, statement of change in equity and notes.
This definition can be summarized as the accounting information
system:
Informatio
n/
Transaction Informatio
s n/ Informatio
identificati Transaction n/
s Informati
on. Transactio
recording. on
ns
reporting.
analysis. Now those
At this level Only valid Post transactions
we only and legally transactions are
in their summarized
select supported
respective into 4 reports.
transaction transaction ledgers and
s that are s are finaly extract
related to recorded balances / T
the Bal.
 Accounting and Bookkeeping
Bookkeeping is a part of accounting involved with
recording either manually or by machine
(computers software) by a bookkeeper.
 Accounting and Computers
Computers are used in processing accounting
data but don’t substitute understanding
fundamental concepts and principles of
accounting.

Why study accounting?

• All are users of accounting information,
therefore it will give you a clear understanding
on how figures are gathered and put together.

• Understand accounting terminology and

 Accountancy as a profession
For one to become a professional accountant, you
must be a licensed Certified Public Accountant
(CPA) after some examination and work
experience.

The work of an accountant

Accountants are employed in three broad fields
a) Public Accounting
b) Private Accounting
c) Government Accounting
 1.2 TYPES OF ACCOUNTING
Accounting is usually seen as having two distinct
strands:

- Financial accounting: This seeks to meet the

accounting needs (4 reports or Financial Statements)
of all the other users (Decision Makers).

- Management accounting: This seeks to meet the

needs of a business’s managers.

The differences between the two types of accounting

reflect the different user groups that they address.
• The nature of the reports produced.

Financial accounting reports tend to be general-

purpose reports. That is, they contain financial
information that will be useful for a broad range of
users and decisions rather than being specifically
designed for the needs of a particular group or set
of decisions.

Management accounting reports, on the other hand,

are often specific-purpose reports. They are
designed either with a particular decision in mind or
 • The level of detail.

Financial accounting reports provide users with a broad

overview of the position and performance of a business
for a period. As a result, information is aggregated and
detail is often lost.

Management accounting reports, however, often provide

managers with considerable detail to help them with a
particular operational decision.
 Regulations
Financial reports, for many businesses, are
subject to accounting regulations , Rules,
Laws, Principles, IFRS….. that exist to try to
ensure that they are produced according to a
standardized format.

Because management accounting reports are

for internal use only, there is no regulation,
Rules, Laws, Principles, IFRS .They can be
designed to meet the needs of particular
 Reporting interval
For most businesses, financial accounting reports are
produced on an annual basis (31st/Dec,yyyy). However, large
companies may produce semi-annual reports and a few
produce quarterly reports depending on their needs.

Management accounting reports may be produced as

frequently as required by managers (on hour basis, daily
basis, weekly basis, monthly basis…. to allows Managers to
check progress frequently.

In many businesses, managers are provided with certain

reports on a daily, weekly or monthly basis.
 Time horizon.
Financial accounting reports reflect the performance and
position of the business for the past period. In essence, they
are backward-looking.

Management accounting reports, on the other hand, often

provide information concerning future performance as well
as past performance.
 Range and quality of information.
Financial accounting reports concentrate on information that
can be quantified in monetary terms.

Management accounting also produces such reports, but is

also more likely to produce reports that contain information of
a non-financial nature, such as measures of physical quantities
of stocks and output.

Financial accounting places greater emphasis on the use of

objective, verifiable evidence when preparing reports.

Management accounting reports may use information that is

less objective and verifiable in order to provide managers with
the information that they require.
 Assignment 1

A) AICPA defined Accounting as the art of recording, classifying and summarizing in a significant
manner and in terms of money transactions and events which are in part at least of financial
character and interpreting the results thereof …”.

B) Generally, the accounting is defined as technique or system that consists of identification,

recording, classifying, summarizing and communicating the financial transactions occurred in the
company.

C) Accounting is the information system that measures business activity, processes the data into
reports, and communicates the resultants to decision makers. Accounting is a language of
business. The better you understand the language, the better you can manage the business.

If we combine all these 3 Accounting definitions we discover that Accounting is the information
system related to the art of identifying, recording, classifying and summarizing, in a significant
manner and in terms of money transactions and events which are in part at least of financial
character. The result of the above process is the production of four financial Reports or Financial
Statements to be communicated and Interpreted to Both users for further decision making.

Required: Explain each word (Accounting technical Term) in red found in the above
definition.
 1.3 JUSTIFICATIVE DOCUMENTS IN BUSINESS TRANSACTIONS

This shows or captures transactions. Source documents are

collected filed and posted it the books of prime entry.

Some of the most important source documents as shown in

the above may include:
 Purchasing order
purchases invoices
sales invoices
credit notes
debit notes
receipts, cheques and petty cash vouchers
other correspondences in business
 A. Purchasing order
This is the letter sent by the buyer to the seller informing
him that he or she needs the goods or services. In this
evidence the buyer gives the full information in detail
about what he or she desires to command in the coming
days. The seller has to respond quickly to this order.
 B. Sales invoice
The sales invoice is raised by the firm /Supplier/Seller and
sent to the customer or buyer / Purchaser / Debtor
/Acquirer when the firm makes a credit sale or when the
customer is in need. The sales invoice contains the
following information.

 The name and full address of the seller;

 The name and full address of the buyer or customer;
 Date of making the sale or invoice date;
 Invoice number
 Amount due ( net of trade discount)
 Quantity of goods to sell;
 Description of goods sold;
 Terms of sale
 C. Purchasing invoice
A purchase invoice is raised by the creditor or seller and
sent to the firm when the firm makes a credit purchase.
It shows the following:

 name and full address of the seller;

 name and address of the buyer or customer;
 date of purchase (invoice date);
 invoice number;
 amount due;
 description of goods sold;
 terms of sales
 signature
 D. Credit note
A credit note is raised by the firm and issued to the debtor when the debtor
returns some goods back to the firm.

The purpose of credit note is to inform the debtor or customer, buyer that the
debtor’s account within the firm has been credited i.e the amount due to the firm
has been reduced or cancelled.

The credit note may also be issued when the firm gives an allowance of the
amounts due from the debtors. From the context we can assume that all credit
notes are issued when goods are returned.

Its contents include:

 name and full address of the firm/creditor;

 name and full address of the debtor;
 amount of credit
 credit note number;
 reason for credit
 signature
 E. Debit note
This is raised by the creditor and issued to the firm when
the firm returns some goods to the creditor.

The purpose of the debit note is to inform the firm that the
amount due to the creditor has been reduced or cancelled.

It includes the following:

 name and address of the firm
 name and address of the creditor
 amount of debit note;
 debit note number;
 reason for the debit note
 signature.
F. Receipts/ Electronic Billing Machine (EBM)

A receipt is raised by the firm and issued to customers or

debtors when they make payments in the form of cash or
cheques.

Its features include:

 The name and address of the firm;

 The date of the receipt;
 Amount received (cash or cheque or other means of
payment);
 Receipt number.
 And the signature.
 G. Cheque
When a firm opens a current account with the bank, the bank issues a
chequebook containing checks. The checks allow the firm to make
payments against the account with the bank.

When a firm issues a cheque to its creditors for payments, it authorizes

the bank to honor payments against the firm’s account with the bank.

The cheque contains the following information:

name and account number of the firm (account holder);

the date of the cheque;
name of the payee(creditor);
name of the firm’s bank;
amount payable in words and figures;
cheque number;
authorized signature(s).
 H. Petty cash vouchers

A petty cash voucher is raised by a cashier to seek

authority for payments (payments of small value in the firm
which require cash payments e.g. fuel, office furniture etc.),
which is approved by a senior manager and filed for record
purpose. This shows:

date of payment;
amount paid out;
reason for payment;
authorized signature(s);
person approving;
person receiving.
Notes: the person receiving the money must return with a
document supporting how the money was used. E.g. fuel
receipt and bus ticket for the good recording of transaction
made.

I. Other correspondence
These include information received within or outside the
firm that has a financial implication in the accounts. For
example:
 Letters from firm’s lawyers about the debtors balance;
 Bank statement from the bank showing bank charges;
 Hire-purchase/credit sale or credit purchase agreements
that relate to non-account assets;
 Memorandum from a senior manager requiring changes
 ASSIGNMENT 2

Choose the best statement

a. All business transactions may be supported

b. All transaction may be legally justified
c. All business transactions must be legally Supported before recording.

Q2. On 01/01/2024 Clemence LLC sells on credit goods equals to 200,000$ to Joanna LLC
(1marks)
a. Sales invoice from Clemence LLC is considered as Purchases Invoice on behalf of Joanna
LLC.
b. This sales invoice is payable not later than 30/01/2024 (date of issuance included)
c. Payment must be done in 30days, weekend and day off excluded.
d. Sales invoice is an obligation on behalf of Joanna LLC and right on behalf of Clemence
LLC
e. a,b,c are correct
f. a,b,d are correct
g. All statements are true
h. No correct statement.
1.4 ECONOMIC FLOWS OR BUSINESS TRANSACTIONS
A business may enter into transactions with outside parties that
affect the firm’s financial position. Examples include the
purchase of office supplies, the performance of a service for
others, the performance by others of a service for the firm,
borrowing cash from bank, and purchase of equipment.

These transactions are recorded by the accountant and are

called external transactions because there is an exchange of
economic resources and or obligations between the firm and one
or more outside parties.

In other words, in an external transaction the firm gives up

something and receives something in return.
Other business activities that do not involve a transaction with
outside parties are recorded because they affect the
relationship between the firm’s assets, liabilities, and owner’s
equity.

Use of office supplies by an employee and use of equipment to

perform a service are examples of internal transactions.

The term transaction is often used to refer to all events that

are given accounting recognition. Some events of importance
to the firm are not recorded because there has not been an
exchange of goods or services.

Examples include receiving an order from the customer,

entering into commitment to purchase an asset in the future,
These examples are not recorded because a transaction has
not taken place at this point. In other words, initially such
events do not affect the firm’s recorded assets, liabilities, or
owner’s equity.
The events will be given accounting recognition in the future
if an exchange takes place.

Financial accounting is based on a framework of rules for

determining which events constitute accounting transactions.

Two of the difficulties you will encounter in the study of

accounting are determining which events to record and
deciding at what stage an event should be given accounting
recognition. Unfortunately, there are no simple rules.
Example: the company X acquires the computer machine from
the company Y at 600,000 rwf and pay cash immediately.The
transaction flows will be:

Machine Computer
Company X Business transaction
Company Y

If we analyze this transaction, we find that one company buys a

machine to another company. The first one is called the buyer or
acquirer or customer of the company Y. the second company is
called the seller or the supplier of that machine and 600,000 rwf
is the value of that transaction.
Company Y
Company
Ressource X Use(Destination)
Machine, value:
(origin)
2.000.000 rwf
Economic flow/B T

The origin of the transaction is the company y and

the destination or user of machine is the company
X.
Company X company Y
USE Espèce, valeur 2.000.000 RESSOURCES(ORIGIN
(DESTINATION)rwf )
Business transaction or
EC

The origin of the transaction is the company y and the

destination or user of machine is the company X.
1.5 APPLICATIONS OF BUSINESS
TRANSACTIONS AND THEIR
CATEGORIES
During the year 2023, the “KIRIKU ltd Co” had realized the
following transactions:
1. bought 20 boxes of Rwanda tea to Rwanda Mountain Tea for
frw 10,000 a box
2. Acquired 20 outs speakers from RBA and paid frw 90,000per
out speaker.
3. Payments respectively of Frw100,000 and Frw40,000 to RMT
and RBA.
4. Sales of 5 boxes of Rwanda tea to Serena Hotels for Frw
15,000each
5. Payment of Frw 20,000 to RBA for the publicity done for the
ended year
6. Payment of Frw 2,000, 000 to James Plc as rent of house to
Frw 400, 000 per month
7. Payment of wages Frw 20,000 to casual workers of the
Required: make presentations of the above transactions on the
behalf of KIRIKU ltd Company by showing the transactions that
are physical, financial, implicit, explicit, internal and external to
that company
Notice: A transaction is:
1. Physical: when it involves the movement of the goods or
other tangibles assets
2. Financial: when it involves the use of cash or other payment
instrument
3. Internal : when is held only inside a company or within a
the same company
4. External : when involves at least two or more companies or
parties
5. Explicit : when it involves the immediately payment of cash
for the bought goods or service
6. Implicit: when it involves the debt for the sold goods or
 1.6 ACCOUNTING INFORMATION SYSTEM

The following diagram shows the components

of an accounting system for a firm that
carries out trading activities. Remember that
the accounting transactions or activities are
based on source documents that permit
recording of their evidence where the
documents are recorded and the postings to
This diagram will be described in next
coming chapters where we will be practically
discussing the recording, posting, extracting
and then preparing the final reports of
business companies.
 1.7 USERS OF ACCOUNTING INFORMATION
Accounting information is produced in form of financial
statement. These financial statements provide information about
an entity financial position, performance and changes in financial
position.

Then financial position of a firm is what the resources the

business has and how much belongs to the owners and others.

The financial performance refers to how the business has

performed, whether it has made profits or losses. Changes in
financial positions determine whether the resources have
increased or reduced.

The users of accounting information have an interest in the

existence of the firm. Therefore, the information contained in the
2. Managers
The managers are involved in day-to-day activities of the
business. They would like to have information on the
financial position, performance, and changes in financial
position so as to determine whether the business is
operating as per the plans. In case the plan is not achieved
then the managers come up with appropriate measures
(controls) to ensure that the set plans are met.
3. Customers
They rely on the business for goods and services. Then the
customers would like to know how the business is
performing and its financial position. This information
would enable them to assess whether they can rely on the
firm for future suppliers.
4. Suppliers or creditors
These people supply goods or services to the firm. The suppliers
are either for cash or credit. The suppliers would like to have
information on the financial performance and position so as to
assess whether the business would be able to pay up for the
goods and services provided as and when the payments fall due.

5. Lenders
These are people and institutions that have main activities of
funding other companies. They have to provide loans and other
sources of capital to businesses. Such lenders include banks and
other financial institutions. They would like to have information
on the financial performance and position of the business to
assess whether the business is profitable enough to pay the
interest on loans and whether it has enough resources to pay
back the principal amount when it is due.
 6. Government and its institutions
The government is interested in the financial performance of the
business to be able to assess tax to be collected in the case there
are any profits made by businesses.

Then the other government agencies are interested with the

financial position and performance of the business to be able to
come with national statistics of different natures. These statistics
measure the average performance of the economy.
 7. Employees
These people are daily working in different business
entities. They would like to have information on the
financial position and performance so as to make
decisions on their terms of employment.

This information would be important as they can use it to

negotiate for better terms including salaries, training and
other benefits. They can also use it to assess whether the
firm is financially sound and therefore their jobs are
secured.
8. The Financial Analysts advisors
Financial analysts and management advisors interpret the financial
information. Examples include stockbrokers who advise investors on
shares to buy in the stock market and other professional consultants
like accountants. They are interested with the financial position and
performance of the firm so that they can advise their clients on how
much is the value of their investments i.e. whether it is profitable or
not and what is the value.
Other advisors would include the press who will then pass the
information to other relevant users.

9. Public
Institutions and other welfare associations and groups represent the
public. They are interested with the financial performance of the firms.
This information will be important for them to assess how socially
responsible is the firm.
This responsibility is in form the employment opportunities the firm
 1. Sole proprietorship
Sole proprietorship as the name suggests, is
where an individual is the sole owner of a
business. This type of business is often quite
small in terms if size (as measured, for
example, by sales generated or number of
staff employed); however, the number of
such businesses is very large indeed.
A proprietorship has a single owner,
called the proprietor, who often manages
the business. Proprietorship tend to be
small retail store or Professional
businesses such as Physicians, Attorneys
and accountants. As to its accounting,
each proprietorship is distinct from its
owner: The accounting records of the
proprietorship do not include the
proprietor’s personal records. However
Examples of sole proprietorship
businesses can be found in most
industrial sectors but particularly within
the service sector. Hence, services such
as electrical repairs, picture framing
photography, driving instruction, retail
shops and hotels have a large proportion
of sole-proprietorship businesses.
The sole-proprietorship business is easy
to immediately (unless special
permission is required because of the
nature of the trade or service, such as
running licensed premises). The owner
can decide the way in which the
business is to be conducted and has the
flexibility to restructure or dissolve the
The law does not recognize the sole-proprietor business
as being separate from the owner, and so the business
will cease on the death of the owner. Although the
owner must produce accounting information to satisfy
the taxation authorities, there is no legal requirement
to produce accounting information relating to the
business for other user groups.
However, some user groups may demand accounting
information about the business and may be in a
position to have their demands met. The sole proprietor
will have unlimited liability which means that no
distinction will be made between the proprietor’s
personal wealth and that of the business if there are
However, some user groups may
demand accounting information about
the business and may be in a position to
have their demands met. The sole
proprietor will have unlimited liability
which means that no distinction will be
made between the proprietor’s personal
wealth and that of the business if there
are business debts that must be paid.
2. Partnership
A partnership exists where there are at
least two individuals, but usually no more
than 20 carrying on a business together
with the intention of making a profit.
Partnerships have much in common with
sole-proprietor businesses.
They are often quite small in size (although
partnerships of accountants and solicitors can be
large as they are permitted to have more than 20
partners).
Partnerships are also easy to set up as no formal
procedures are required (and it is not even
necessary to have a written agreement between the
partners). The partners can agree whatever
arrangements suit them concerning the financial
and management aspects of the business, and the
partnership can be restructured or dissolved by
agreement between the partners.
 Partners of a business usually have unlimited
liability, although it is possible to grant limited to
partners who have no say in the running of the
business.
3. Limited liability partnerships (LLPs) and
Limited liability companies
Limited companies can range in size from quite
small to very large. The number of individuals who
subscribe capital and become the owners may be
unlimited, which provides the opportunity to create
a very large-scale business.
The liability of owners, however, is limited
(hence limited company), which means that
those individuals subscribing capital to the
company are liable only for debts incurred by
the company up to the amount that they
have agreed to invest. This cap on the
liability of the owners is designed to limit risk
and to produce greater confidence to invest.
Without such limits on owner liability, it is
difficult to see how a modern capitalist
In many cases, the owners of a limited
company are not involved in the day-to-day
running of the business and will only invest in
a business if there is a clear limit set on the
level of investment risk.

The other classification may include:

a. Public company: is the form of company
created and managed by the state. It can
offer its shares for sale to the general public.
b. Private company: is the form of
company created and managed by the
owners or private people.
Private limited company tend to be
smaller businesses where the ownership
is devided among relatively few
shareholders who are usually fairly close
to one another for example, a family
company.
 4. Corporation
A corporation is a business that may be
owned by a few persons or by
thousands of persons and is
incorporated under laws. Almost all
large businesses are corporations. The
corporation is unique in that it is a legal
business entity. The owners of the
corporation are called stockholders or
They buy shares of stock, which are units of
ownership, in the corporation. Should the
corporation fail, the owners would lose only the
amount they paid for their stock. The personal
assets of the owners are protected from the
creditors of the corporation.
Therefore, the stockholders do not directly
manage the corporation. They elect a board of
directors to represent their interests. The board
of directors selects the officers, such as the
president and the vice presidents, who manage
the corporation for the stockholders.
STRUCTURE OF A CORPORATION
 5. A not-for-profit

A not-for-profit is an organization that has been approved by the Internal

Revenue Service to operate for a religious, charitable, or educational
purpose. A board, usually composed of volunteers, makes the decisions
for the not-for-profit organization. Board members have fiduciary
responsibility, which is an ethical and legal obligation to perform their
duties in a trustworthy manner. Their goal is to raise cash to fund their
operations. Examples of not-for-profit organizations are the United Way,
churches, and schools. A not-for-profit has no owners.
1.8. ACCOUNTING CONCEPTS
AND PRINCIPLES
These are broad rules adopted by the accounting
profession as guidelines in measuring, recording and
reporting the financial affairs and activities of a
business. They consist of a number of concepts,
principles and procedures. The rules, conventions
and practices developed over time by the accounting
profession are called generally accepted accounting
principles. Sometimes also called standards, they
include the assumptions, concepts and practices that
serve as general guidelines in the preparation of
financial reports to make accounting information
reliable, understandable and comparable.
Principles or standards become generally accepted by
obtaining the substantial authoritative support of
accounting profession. The most authoritative bodies are
the American institute of certified public accountants, the
financial accounting standards board and the Securities
and Exchange Commission. These groups, with the help
of extensive research staffs, study reporting alternatives
for various transactions and select the one that results in
the most useful presentation of financial information.
Other groups such as the American
accounting association, the national
association of accountants and the
financial executives institute also
influence the development of
accounting principles by conducting
research and recommending
reporting alternatives to those
responsible for setting accounting
Since accounting principles evolve (are
developed) or (established) in accordance with
changes in the business environment, it is not
possible to present a complete list of generally
accepted accounting principles. There are,
however, several broad principles that serve
as basic guides in the selection of specific
rules and practices. Knowledge of these broad
principles will help us to better understand the
general framework within which accounting
A. Generally Accepted
Concepts in Accounting
 1. Entity Concept
For accounting purposes, every business is perceived and treated
as if it is a separate entity that is distinct from its owner or owners
and from every other business. A basic principle of accounting is
that information is accumulated for a specific area or unit of
accountability called an entity. An accounting entity is an economic
unit that controls resources and engages in economic activity. To
accumulate financial information, the accountant must be able to
clearly identify the boundaries if the unit is accounted for. Business
activities of the entity are separated from both the personal
activities of its owners and those of other entities.
An entity may be individual, a governmental agency, a nonprofit
organization, a business enterprise, or an organizational subunit.
When financial reports are prepared, they must identify clearly the
entity being reported on.
2. Continuing-concern (Going-concern
concept)
A Balance Sheet (a statement of financial
position) is prepared under the assumption
that the business will continue in operation.
Therefore, since the assets are held for use in
the business are not for sale, their current
market values are not particularly relevant
and need not be shown. However, if a
business is about to be sold or liquidated, the
continuing concept and cost principle don’t
Because it is not possible to predict how
long a business will exist, an assumption
must be made. Past experience indicates
that the continuation of operations in the
future is highly probable for most
companies.
Thus, it is assumed that the business will
continue to operate at least long enough to
carry out its existing commitments. This
assumption is called going concern
Adoption of the going concern assumption has important
implications in accounting. For example, it provides
justification for the use of historical costs in accounting for
plant assets and for the systematic allocation of their cost to
depreciation over their useful lives. Because it is assumed that
the assets will not be sold in the near future but will continue
to be used in operating activities.
Although the going concern assumption is followed in most
cases, it should not be applied when there is conclusive
evidence that the business will not continue. If management
intends to liquidate the business, the going concern and
historical cost principles are set aside and financial
statements are prepared on the basis of expected liquidation
values. Thus, assets are reported at their expected sales
values and liabilities at the amount needed to settle them
 3. Stable Monetary Unit Concept
It states that accounting reports should be based on the
assumption that the value of the monetary unit does not
change over a period of time. Money is used in accounting
as the common denominator by which economic activity is
measured and reported.
Accountants assume that data expressed in terms of
money are useful in making economic decisions and that
the monetary unit represents a realistic unit of value that
can be used to measure net income, financial position and
changes in financial position.
Inherent in the use of money as a unit of measure is the
assumption that the value of money remains constant
over time.
 4. Time Period Concept
Activities of a business are definite as occurring during
specific time periods such as months or years. Then financial
reports that show the results of operations are prepared for
each period. A completely accurate report of the degree of
success achieved by a business cannot be obtained until the
business is liquidated. Only then can net income be
determined precisely. Users of financial information, however,
need timely information for decision-making purposes.
Accountants must thus prepare periodic reports on the results
of operations, financial position and changes in financial
position. To do so, accountants have adopted the time-period
assumption that is, they assume that economic activity can
be associated realistically with relatively short time intervals.
B.Generally Accepted
Principles in Accounting
1. OBJECTIVITY PRINCIPLE

The objectivity principle holds that, if possible, accounting

information should be factual and verifiable. Verifiability
means that the data are supported by adequate evidence
that supports the validity of the data. If information is
objective and verifiable, essentially similar measures and
results would be produced it two or more qualified persons
examined the same data. Although accountants seek the
most objective evidence available, we must recognize that
accounting data are not completely objective because there
are many cases in which estimates must be made on the
basis of personal judgments and observations.
 2. THE COST PRINCIPLE

The need for objective, verifiable data is the basic

reason for the use of historical cost in accounting.
Resources acquired are recorded at their cost as
measured by the amount of cash or cash
equivalent given to acquire them.Under this
principle, all goods and services purchased are
recorded at cost. Costs are measured on a cash
or cash equivalent basis.
 3. THE REVENUE REALIZATION PRINCIPLE
An important accounting function is the determination of periodic net income the
process of identifying and measuring revenues and expenses for a specified time
period. Revenue for a period is determined by applying the revenue realization
principle, which provides guidance as to when revenue should be recognized.
Essentially, the realization principle provides that revenue should be recognized under
accrual accounting when it is earned. States that the inflow of assets associated with
revenue does not have to be in the form of cash. Requires that revenue be recognized
at the time, but not before it is earned. Revenue is said to be earned at the time
services are rendered or at the time title to goods is transferred. The principle also
requires that the amount of revenue recognized be measured by cash received plus the
cash equivalent (fair value) or any other asset or assets received.
Some revenue, like interest revenue and rent revenue, is earned with the passage of
time and is therefore not difficult to associate with specific time periods. On the other
hand, sales revenue is earned in a continuous process as the activities that give rise to
revenue take place.
 4. THE MATCHING PRINCIPLE
Revenue is an inflow of assets from the sale of goods or
performance of services. Expenses are the assets used up in the
process of producing revenue. It requires that expenses be
reported on the income statement (statement of comprehensive
income) in the same accounting period as are revenues that
were earned as a result of the expenses.
In general terms, under accrual accounting, revenues are
recognized when they are earned and expenses recognized (or
matched against revenue) as assets are used.
Just as the realization principle has been developed by
accountants to serve as a guide in the timing of revenue, the
matching principle has been developed to guide the timing of
expense recognition.
 5. THE PRINCIPLE OF CONSISTENCY
Various accounting practices should remain the same from one year to another. Example the method of
valuation of stock should be the same. Several generally accepted alternative accounting methods will
be described in late chapter. For example, inventory methods include FIFO, LIFO, and average and
depreciation methods include straight-line, sum of the year’s digits, declining balance and units-of-
production.

The methods adopted have a significant effect on the amount of net income reported for a period as
well as on financial position at the end of the period. Although accounting statements for any given
period may be useful in themselves, they are more useful if they can be compared with similar
statements of prior periods.

To improve the comparability of accounting date, accountants follow the consistency principle, which
requires that once a particular accounting method is adopted, it will not be changed from period to
period. Without this principle, large changes in the accounting methods used rather than from changes
in business conditions or general managerial effectiveness.

The principle of consistency does not mean that a company can never change an accounting method. In
fact, a change to a new method should be made if the new method provides more useful information
than the previous method
 6. THE FULL DISCLOSURE PRINCIPLE
Its meaning is that a business’s financial statements including
footnotes should contain all relevant information about the
operations and financial position of the entity. Some items to be
reported in order to satisfy this principle include: Contingent
liabilities, long-term commitments under a contract, and
accounting methods used. The full disclosure principle requires
that all relevant information affecting net income and financial
position must be reported in the financial statements or in
footnotes to the financial statements although this does not
mean that information must be reported in great detail.
Because many alternative accounting methods exist and
because the methods adopted can affect significantly the
financial position and results of operations of a company,
knowledge of the methods used is essential for statement users.
In addition to the disclosure of accounting methods,
other items typically disclosed include:
- The components of inventory such as raw
materials, work in process and finished goods;
- The components of the income tax provision;
- The terms of major debt agreements;
- The nature of any contingent liabilities such as
lawsuits;
- Identification of assets pledged as security for
loans;
- The nature of contractual agreements for leases,
pension plans and stock option plans;
- Major transactions affecting stockholders equity;
 7. MATERIALITY
Materiality is used in accounting for refer to the relative size or
importance of an item or event. Accounting is a practical art
rather than an exact science. Although accountants generally
apply the most theoretically sound treatment to transactions and
events, they sometimes deviate from that practice because the
effect of a transaction or event is not significant enough to affect
decision: the effect is not relevant.
For example, small expenditures for plant assets are often
expensed immediately rather than depreciated over their useful
lives to save clerical costs of recording depreciation and because
the effects on the income statements and balance sheets over
their useful lives are not large enough to affect decisions.
In summary, an item is material if there is a reasonable
expectation that knowledge of it would influence the decisions of
 8. CONSERVATISM
Accountants must make many difficult judgments and estimates
when determining the proper treatment of business transactions. In
reaching a decision, they must rely on the principles described
earlier in an effort to make a fair presentation of the factual effects
of the transactions.
When this approach fails and doubt exists, accountants apply the
convention of conservatism, which says in essence: when in doubt,
choose the solution that is least likely to overstate assets and
income for the current period. Conservatism is a useful approach in
accounting but should be applied only when uncertainty prevents
the reporting prevents the reporting of factual results. Nothing in
the convention of conservatism suggests that accountants should
understate income or assets. It is not permitted to show in financial
statement a position better than what it is. It is also not proper to
show a position substantially worse than what it is.
Conservatism in accounting means reporting items in the
financial statements at amounts that lead to the most
cautious immediate results.

Some guidelines are:

a) Do not anticipate gains, but provide for all probable

losses.

b) If in doubt, record an asset at the lowest reasonable

amount and a liability at the highest possible amount.

c) When there’s a question, record an expense rather than

an asset.
 9. ACCRUAL PRINCIPLE
When an event takes place or a transaction is
entered into, its consequences are bound to
follow.There are three conventions regarding
financial statements.
 10. Dual Aspect Principle

For any accounting transaction, at

least two accounts are involved
one to give and another one to
receive