When it comes to financial statements, it’s important to understand the fundamental accounting assumptions that underlie their preparation and presentation. These assumptions, which include going concern, consistency, and accrual, are not required to be explicitly disclosed, but final users should be aware of them.
Going Concern Assumption
The going concern assumption is the idea that an enterprise will continue to operate in the foreseeable future. In other words, the enterprise has neither the intention nor the necessity of liquidation or materially curtailing the scale of its operations. Financial statements are typically prepared on the basis of this assumption, which recognizes the need for sufficient retention of profit to replace assets consumed in operation and for making adequate provision for settlement of its liabilities.
It’s important to note that if there is an intention or necessity to liquidate the enterprise or curtail materially the scale of its operations, financial statements may not be prepared on a going concern basis. Any financial statement that is prepared on a different basis, such as when assets are stated at net realizable values, must be disclosed.
Going Concern Assumption in Accounting: Significance & Implications
Consistency Assumption
The consistency assumption refers to the practice of using the same accounting policies for similar transactions from one accounting period to another. This assumption improves the comparability of financial statements over time. While change in accounting policy is permitted in exceptional circumstances, such as when required by statute or accounting standard or for a more appropriate presentation of financial statements, consistency is generally the norm.
Consistency in Accounting: Key to Trustworthy Reporting
Accrual Assumption
The accrual assumption is the idea that revenues and costs are recognized as they are earned or incurred, not when money is received or paid. Transactions are recognized as soon as they occur, whether or not cash or cash equivalent is actually received or paid. This basis ensures better matching between revenue and cost, and profit or loss is calculated based on accruals, reflecting the activities of the enterprise during an accounting period rather than just its cash flows.
However, the accrual basis exposes an enterprise to the risk of recognizing income before actual receipt, which can overstate divisible profits. Accounting standards require that no revenue should be recognized unless the amount of consideration and actual realization of the consideration is reasonably certain. Despite the possibility of distributing profit not actually earned, the accrual basis of accounting is generally followed due to its logical superiority over cash basis accounting.
Accrual Basis of Accounting: Key Concepts, Pros, and Cons Explained
Matching Principle in Accounting: Key to Accurate Financial Reporting
Conclusion
In conclusion, fundamental accounting assumptions play a crucial role in the preparation and presentation of financial statements. While these assumptions are usually assumed and not disclosed, it’s important to understand them and their implications for financial reporting. By understanding the going concern, consistency, and accrual assumptions, final users of financial statements can make more informed decisions based on the financial information provided.
AS-1 Related Posts:
Key Considerations in Selection of Accounting Policies as per AS-1
Nature of Accounting Policies and Disclosure Requirements of AS-1
Alternative Accounting Treatments and AS-1 of ICAI
Fundamental Accounting Assumptions as per AS-1
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