3. Basic Concepts
Accountants agree that for the growth and development of accounting theory it is necessary to have a basic framework on which to build. This foundation is the group of concepts or postulates generally accepted at face value. There is some lack of agreement as to whether some statements are concepts to be accepted without prof, or conventions to be used as general guides, or principles offering the best of alternate choices under specific circumstances. It is agreed that concepts are more basic in the development of accounting theory than are conventions and principles. Homewer, the difference is not so great that the lack of agreement will cause great harm. The development of accounting theory is not seriously hindered because some accountants consider consistency and conservatism to be conventions while others consider them to be concepts.
Because of the lack of agreement as to the classification of some statements, it would be impractical to list all accounting concepts. However, four of the more generally recognized concepts are: “going concern,” “business entity,” “dolar as a unit of measure,” and “stability of the dolar.”
Going Concern. It is assumed that the economic unit under consideration will continue indefinitely. Therefore, in preparing the usual accounting statements for a firm, no consideration is given to possible liquidaiton values of assets or the effect that such consideration might have on profits. Under this concept, only such portions of costs as are allocable to current activities are charged against current income. This is often referred to as the continuity concept.
Business Entity. Before an accounting system can be developed for a particular firm, the scope and identity of the firm must be established. If suc limit sor boundaries were not established, the resulting confusion would make it impossible to establish a usable accounting system. Are the owners to be considered a part of the business? Questions such as this must be answered before an accounting system can be established.
The firm is generally considered to be an entity in its own right, separate and distinet from the owners or those who provide the funds for it. İn some cases, a single proprietor separates his personal activities from his business activities; in other cases, he considers them as a single unit. In corporations it is common to find consideration given to the business or economic entity concept, in that a corporation owning one or more subsidiaries which are separate legal entities prepares consolidated statements fort he entire group as if all formed a single entity. Also, a corporation is considered to be a business unit entirely separate from its owners.
Dollar as a Unit of Measure. This broad concept encompasses several other equally important but more limited concepts such as cost concept, costs attach concept, and the matching of expenses and revenue concept.
When accounting was defined in such a way as to restrict it to business transactions having a financial aspect, it was correct to state that the onlıy common unit of measure was a unit of money – in the United States, the dollar. With the broadened concept of accounting have come measures available for special purposes, such as man-hours or units of material. Although the most common measure is stil the dollar. For financial accounting, the dollar remains the only acceptable measure.
Accountants are still firmly committed to a cost basis. Under the cost concept assets are valued at their original cost less proper deductions, rather than avaluated on arbitrary bases. Te cost basis has the advantage of being objective and impersonal whereas other methods, such as appraisals, tend to be subjective.
The cost attach concept is a further development of the cost concept. The cost of various units may be combined or merged to obtain the cost of a larger or more complex unit. This is especially evident in the production of inventory items where costs of various items of raw material, semi-finished parts or components, direct labor, and overhead are combined to establish the cost of the unit of finished goods.
The matching of expenses and revenue concept ( often referred to as matching of costs and revenue ) is basic to the periodic determination of income for a going concern. The determinationof periodic income is being granted increased importance in accounting and financial circles. It is indicated by the shift in emphasis from the balance sheet to the income statement. The determination of the profitability of a firm is of utmost importance to creditors, owners, and management; and profit can be determined fairly only by the proper matching of periodic expenses with periodic revenue. The problem of matching expenses and revenue is basically one of discovering suitable bases of association. Which costs should be considered to have expired in the current period and which should be carried forward to be “expensed” in future periods? Which revenues should be considered actually earned in the current period and which should be deferred and recognized as earned in future periods?
Stability of the Dollar. The Dollar is the generally accepted unit of measure in accounting. To be useful, a unit of measure must be constant. This is true whether measures refer to weight, length, or value. Accounting follows the basic concept that the value of a dollar remains constant while other things may change in value in relation to a dollar. Accountants recognize that in times of inflation the reverse may be true; that is, the value of nonmoney items may remain constant while the value of a dollar changes. However, the accounting profession generally feels that although there are evident imperfections in the stability of the dollar concept, it is so much beter than any suggested alternative that it should be maintained.
In times of inflation or deflation, pressures increase fort he adjustment of historical cost to reflect changes in the price level. The American Institute of Certified Public Accountants and the American Accounting Association do not recommend departure from the cost basis of accounting. However, they suggest the use of supplementary data to show the effect of price-level changes.
