Question

Describe the basic assumptions of accounting.

Short answer

The basic assumptions of accountingare:

• Business entity assumption.
• Accounting period assumption.
• Going concern assumption, and
• Money measurement assumption.

Step-by-step solution

Meaning of Accounting

Accounting is 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 a financial character, and interpreting the results thereof.

 Step 2: Basic assumptions inaccounting

Accounting assumptions may be defined as the methods or procedures used in accounting for events reported in financial statements.

The basic assumptions of accounting are as follows:

• Business entity assumption:According to this concept business is treated as a separate entity from its owners. All transactions of the business are recorded in the books of the firm. Business transactions and business property are different from the personal transactions and personal property. If business affairs are mixed with the private affairs, the true picture of the business is not available. The business entity concept to all forms of business organization. The owner of the firm is treated as a creditor to the extent of his capital. From the accounting point of view, the owner is different and the business is different.

• Accounting period assumption: According to this assumption, it is necessary to prepare the financial statements periodically to ascertain the profit or loss and financial position of the business. It also helps the interested parties to make periodical assessment of its performance. Therefore, accountants choose some shorter period to measure the results and one year has been generally accepted as the accounting period. Accounting period may be a calendar year or any other period of twelve months. The final accounts are prepared at the end of each accounting period, and the financial reports assist the users in making good decisions, corrective measures, business expansion as well as making assessment of the progress of the enterprise.

• Going concern assumption: It is assumed that every business would continue for a long period. Keeping tothis view, the investors lend money and the creditors supply goods and services to the concern. Recording of transactions in accounting is done according to whether the benefits from expenses are immediate (short period, less than one year) or for the long term. If the benefits from expenses are immediate,these are treated as revenue; if the benefits are for the long term, these are to be treated as capital, depending upon the nature of the business. However, this assumption is not applicable if the concern has gone into liquidation or it has become insolvent. In such a case, the assets are valued at their current values and the liabilities at the value at which they are to be met.

• Money measurement assumption: According to this concept, money is adopted as a common measuring unit for the purpose of accounting. All recording, therefore, is done in terms of the standard currency of the country where business is set up. For example, in India it is done in terms of Indian Rupees,in the USA it is done in terms of US Dollars,and so on. Another implication of money measurement is that only those transactions and events which can be expressed in monetary termsare recorded in the books of accounts. The limitation of this concept is that it is based on the assumption that the money value is constant, which is not true. This concept ignores the qualitative aspect of things, and the impact of inflationary changes is also not adjustable as perthis assumption.

Hence, these are regarded as the basic or main assumptions of accounting.