5 Key Accounting Assumptions

Accrual basis is a more logical and practical approach for the determination of profit with cash as the basis of accounting. But it’s worth noting that it exposes a firm to the risk of understanding any income before it is actually received. This implies that an accrual basis runs the risk of overstating any divisible profit.

B. Implications for Financial Reporting

Going Concern Assumption – the company will remain in business and will carry out existing commitments. In the event that liquidation is imminent, the entity may be required to apply the liquidation basis of accounting under the guidance in FASB ASC , Presentation of Financial Statements—Liquidation Basis of Accounting. She must use Generally Accepted Accounting Principles (GAAP) to reflect company accounts very carefully to ensure the success of her employer. In such a scenario, the lack of seriousness is reflected in the case of the latter, which ultimately raises doubts in the minds of the stakeholders. However, certain warnings or signs need to be considered while concluding the company’s going concern status. The application of the economic entity concept has significant importance because of the following reasons.

B. Importance for Investors and Regulators

• This prevents accountants from over estimating future revenues and underestimated future expenses that could mislead financial statement users.
• Accounting assumptions provide the foundation for consistent, reliable, and transparent financial reporting.
• Materiality also allows for a mid-size company to report the amounts on its financial statements to the nearest thousand dollars.
• This article explores the key principles of the materiality concept and its role in financial reporting and decision-making.
• Hence, the concept says that all relevant and material facts or figures about an organisation must be disclosed in its financial statements.

Companies often accompany GAAP-compliant measures with non-GAAP figures in their financial statements. When a figure is non-GAAP, the company must say so and investors should pay heed to that fact. Companies are able to defer the recognition of some expenses, such as depreciation, to later periods because it is assumed they will continue to operate in the future. Thus, it can be said that the primary objective of accounting standards lies in harmonising various types of accounting policies, which, in turn, help in drafting the final financial reports.

B. Enhancing Comparability Across Businesses

These metrics would be less meaningful if they were based on cash accounting, as they would not accurately reflect the company’s economic activities. The accrual basis assumption thus enables analysts to make more precise comparisons between companies and across different periods. An accounting assumption is a set of rules that helps to ensure financial reports of the business are prepared in line with applicable accounting standards. It lays a strong foundation for consistent, reliable, objective, and valuable financial information. Accounting assumptions provide a basis for consistency and reliability that helps readers of financial statements compare financial performance and make a decision based on it.

Step 4: Evaluate IFRS vs. US GAAP Differences

The reliability accounting assumption states that only transactions that can be proven should be recorded in accounting practices. And what this means is that businesses must be able to prove transactions through such things as receipts, billing statements, invoices, and bank statements. There must be some form of objective evidence of a transaction 5 key accounting assumptions before the business can report it in its accounting records.

When these assumptions are not followed, it can often lead to financial statements that are unsound. While there are several accounting assumptions that businesses will want to follow, the following five assumptions described below are considered to be some of the most important. Reliability assumption The reliability assumption means the company has objective evidence of its recorded information in the financial statements.

Adapting to Changes in Accounting and Business Environment

This made financial statements harder to compare and made it far easier for companies to skew their numbers positively. The conceptual framework sets the basis for accounting standards set by rule-making bodies that govern how the financial statements are prepared. The going concern concept assumes that an organization would continue its business operations indefinitely. It means that it is assumed that the business will run for a long period of time, and will not liquidate in the foreseeable future. It is because the going concern concept provides the firm with the basis to show its assets’ value in the balance sheet.

These Concepts are developed over time to bring consistency and uniformity to the accounting process. It follows that the financial statements only give a partial picture of the state of a business. Matching Principle – states that all expenses must be matched and recorded with their respective revenues in the period that they were incurred instead of when they are paid. This principle works with the revenue recognition principle ensuring all revenue and expenses are recorded on the accrual basis.

However, it does not mean that the organization cannot change its accounting policies when necessary. The firm can make required changes in its policies by properly indicating the probable effect of the changes on its financial results. For example, if a company’s management wants to compare the net profit of the current year with the previous year, it can do so only when the accounting policies followed by the company in both years are the same.

Assumption of a time period

• In order to differentiate a fact as material or immaterial, one should consider its nature and the amount involved.
• This is the reason why the accounting standards assumption demands that a business should not recognise any amount unless that the actual realisation amount has been ascertained.
• Therefore, the firm will initially record the amount as a liability in the unearned revenue account.
• This principle works with the revenue recognition principle ensuring all revenue and expenses are recorded on the accrual basis.
• This gives stakeholders a more reliable view of the company’s financial position and does not overstate income.

Accounting assumptions are one part of a framework established by an agreed set of accounting principles, as illustrated in the diagram below. Accounting assumes the business will continue for a long period of time and transactions are recorded on this basis. Golden rules of accounting refer to a set of pre-defined principles which guides the sequential way of recording the transactions using double entry system of bookkeeping .

It becomes easy for the readers of the financial statements to compare the same for different periods. Accounting assumptions refers to a set of rules that ensures the business operations of an organization are conducted efficiently and as per the standards defined by the FASB (Financial Accounting Standards Board). These assumptions, in addition to accounting principles and concepts, become guidelines for any business firm letting them operate in order. Under this assumption, it is important that companies make sure that they use the same accounting method across all accounting practices and accounting periods.