Question

What are the four basic assumptions that underlie the financial accounting structure?

Short answer

The four basic assumptions that form the basis of financial accounting structure are business entity assumption, accounting period assumption, going concern assumption, and money measurement assumption.

Step-by-step solution

Meaning of Financial Accounting

The objective of financial accounting is to find out the profitability and to provide information about the financial position of the concern. Two important statements of financial accounting are income and expenditure statement and balance sheet.

Four basic assumptions of financial accounting structure

• Business entity assumption: According to this assumption 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 personal transactions and personal property. If business affairs are mixed with 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 find out the profit or loss and financial position of the business. It also helps the interested parties to make a 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. The 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 financial reports assist the users in making a good decision, corrective measures, business expansion as well as making the assessment of the progress of the enterprise.

• Going concern assumption: According to this concept, every business wants to survive in the market for a long time and earn profit from business operations. This notion is useful for the business to understand the major aspects of the business and helps in the conduct of the business. This concept ensures investors and stakeholders that the business is stable and earning revenue.

• Money measurement assumption: According to this concept, the money is considered as the only way to record the transaction into the company’s book of accounts. Therefore, all recordings are made with reference to the standard currency of the country where the business is established. In simple words, in can be understood as only those transactions and events are recorded in the books of accounts which can be expressed in monetary terms.