Accounting and Finance Foundations

Unit 5

Accounting and Finance Foundations Unit 5: Accounting Terminology 314

Accounting Terminology

Chapter 12

Lesson 12.6 US GAAP Accounting: Assumptions,

Principles, and Constraints

1. Entity Assumption
   Accounting records are kept for entities and not the people who own or run the company.
   The entity assumption presumes that the business is a separate entity from its owners or other firms.
   Even in proprietorships and partnerships, the accounting records for the business must be kept
   separate from those of the owner(s). The concept entity states that a business is considered its own
   person; therefore, its records must be kept separate. For example: a business can marry (merger). A
   business can have a baby (subsidiary). A business can die (it closes or discontinues operations).


2. Going Concern Assumption
   Financial statements are prepared with the expectation that a business will remain in operation
   indefinitely.
   This concept implies that financial statements do not represent a company’s worth if its assets were
   to be liquidated (the ease an asset can be converted to cash), but rather that the assets will be used
   in future operations. This concept also allows businesses to spread (amortize) the cost of an asset
   over its expected useful life.


3. Monetary Unit Assumption
   For an accounting record to be made, the assumption presumes a stable currency to be the unit
   of record.
   Financial statements show only a limited picture of the business. Consider a situation where there is
   a labor strike pending or the business owner’s health is failing; these situations have a huge impact
   on the operations and financial security of the company, but this information is not reflected in the
   financial statements.


4. Time Period Assumption
   This concept defines a specific interval of time for which an entity’s reports are prepared.
   This can be a fiscal year (July 1 - June 30), natural year (January 1 - December 31), or any other
   meaningful period such as a quarter or a month. Once a time period is determined, it must not
   be changed.


5. Cost Principle
   An asset is entered into the accounting records at the price paid to acquire it.
   Because the “worth” of an asset changes over time, it would be impossible to accurately record the
   market value for the assets of a company. To simplify practices, the amount recorded is the purchase
   price of the asset.

Student Guide