Basic Accounting Assumptions
Financial statements are multipurpose documents used by many different parties for different reasons. Management use them to control their business and to make useful business decisions. Bank managers use them to decide whether loans and overdrafts should be given. Suppliers use them to decide whether credit terms should be extended. Investors use them to decide whether to invest or not.
For this reason financial statements need to be based on a generally agreed accounting framework or structure so that all parties understand how they are produced. Accounting assumptions can be considered to be the foundations on which this accounting framework is based.
What are the Accounting Assumptions?
The four basic accounting assumptions are as follows:
- Money Measurement Accounting Assumption
- Business Entity Accounting Assumption
- Time Period Accounting Assumption
- Going Concern Accounting Assumption
Everything is recorded in terms of money. Items which cannot be recorded in terms of money are ignored and not included. It follows that the financial statements only give a partial picture of the state of a business.
For accounting purposes the business is treated as a separate entity from the owner. The accounting records show transactions of the business not the owner.
The business should report its financial activities over a fixed time period usually annually, quarterly or monthly. This is sometimes referred to as the periodicity assumption.
Accounting assumes the business will continue for a long period of time and transactions are recorded on this basis.
Accounting Assumptions and Accounting Principles
Accounting assumptions are one part of a framework established by an agreed set of accounting principles, as illustrated in the diagram below.
The accounting principles diagram is available for download in PDF format by following the link below.