What are the two underlying assumptions in preparing financial statements?

Financial accounting relies on several underlying concepts that have a significant impact on the practice of accounting.

Assumptions

The following are basic financial accounting assumptions:

• Separate entity assumption - the business is an entity that is separate and distinct from its owners, so that the finances of the firm are not co-mingled with the finances of the owners.

• Going concern assumption - the business is going to be operating for the foreseeable future.

• Stable monetary unit assumption - e.g. the U.S. dollar

• Fixed time period assumption - info prepared and reported periodically (quarterly, annually, etc.)

Principles

The basic assumptions of accounting result in the following accounting principles:

• Historical cost principle - assets are reported and presented at their original cost and no adjustment is made for changes in market value. One never writes up the cost of an asset. Accountants are very conservative in this sense. Sometimes costs are written down, for example, for some short-term investments and marketable securities, but costs never are written up.

• Matching principle - matching of revenues and expenses in the period earned and incurred.

• Revenue recognition principle - revenue is realized (reported on the books as earned) when everything that is necessary to earn the revenue has been completed.

• Full disclosure principle - all of the information about the business entity that is needed by users is disclosed in understandable form.

Modifying Conventions

Due to practical constraints and industry practice, GAAP principles are not always applied strictly but are modified as necessary. The following are some commonly observed modifying conventions:

• Materiality convention - a modifying convention that relaxes certain GAAP requirements if the impact is not large enough to influence decisions. Users of the information should not be overburdened with information overload.

• Cost-benefit convention - a modifying convention that relaxes GAAP requirements if the expected cost of reporting something exceeds the benefits of reporting it.

• Conservatism convention - when there is a choice of equally acceptable accounting methods, the firm should use the one that is least likely to overstate income or assets.

• Industry practices convention - accepted industry practices should be followed even if they differ from GAAP.

  When we talk about financial statements, we normally refer to the four main types of the financial statements. Those are statement of financial position which we normally call Balance Sheet, Statement of comprehensive income or income statement, statement of changes in equity and finally statement of cash flow. Each statement serve for different purposes. The primary objective of providing the information of such statements is to see the financial position, performance and cash flows of an entity which is very useful for economic decision making.

  Four Fundamental Assumptions in preparing Financial Statements that You Should Know

  There are four main fundamental assumptions that you should know when preparing the financial statements to ensure that they are at high quality. Those are fair presentation, going concern, accruals and consistency

  Fair presentation

  Fair presentation is an assumption to ensure that the financial statements are prepared and presented fairly the financial position, performance and cash flows in accordance with all relevant International Accounting Standard (IASs)/International Financial Reporting Standard (IFRSs). This means that an entity need to disclose about the compliance with the IASs/IFRSs and all relevant IASs/IFRSs must be followed if the entity is in compliance with IASs/IFRSs.

  In addition, an entity cannot rectify even though they provide any disclosure of accounting policies or explanatory notes if they has used an inappropriate accounting treatment.

  Going Concern

  Basically, going concern is one of the concept that assumes the business activities will continue for foreseeable future and there is no any intention to liquidate nor scale down its operations in a material way. In practice, we normally examine the going concern by looking at the revenue growth of an entity as well as the long term business planning. We can also examine by looking at the valuation of assets. To be in the going concern, an entity should not value it assets at the break-up value; the amount that would be sold off and the business is broken up. 

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  Accruals

  Accruals basis of accounting is one of the accounting concept that recognize revenues and expenses when they are earned or incurred regardless of cash receipt or payment is made. Similar to the matching principle, in calculating and recognizing the revenue earned, the expenses must be matched against that revenue recognition in that particular period.

  Consistency

  Consistency of presentation refers to the presentation and classification of items in the financial statements should be in the same way from one period to another. There are two exceptions where an entity can depart from this consistency principle. First, when there is a significant changes in the nature of operations or a review of financial statements indicate to be more appropriate presentation. Last but not least, when the changes in presentation is required by IFRS.

  In addition, apart from the four fundamental assumptions mentioned above, IAS 1 also considers three other concepts which are extremely important in preparing the financial statements. Those are prudence, substance over form and materiality.

  We consider an entity as prudence when assets or income are not materially overstated and liabilities and expenses are not materially understated.

  Substance over form is where transactions and other events are recorded for and presented in accordance with their substance of economic reality not based on their legal form.

  Finally, in preparing the financial statements, an entity should also take into account the materiality. Information is considered as material when its omission or misstatement could influence the economic decision. Therefore, in preparing the financial statements, any material items should be disclosed separately while the immaterial items can be presented in aggregation with amount of similar nature or function.

  What are the two basic underlying assumptions that must be employed in financial statements prepared in accordance with IFRS?

  Underlying Assumptions of IFRS There are two fundamental assumptions underlying the financial statements: Going Concern, and Accruals.

  What are the two underlying assumptions in business?

  Separate entity assumption - the business is an entity that is separate and distinct from its owners, so that the finances of the firm are not co-mingled with the finances of the owners. Going concern assumption - the business is going to be operating for the foreseeable future.

  What are the 2 most important financial statements?

  This will be followed by the two essential financial statements:.

  The balance sheet (sometimes also known as a statement of financial position).

  The income statement (which may include the statement of retained earnings or it may be included as a separate statement).

  Which is the underlying assumption of financial statements as stated in the conceptual framework for financial reporting?

  According to the Framework of IAS/IFRS, the underlying assumptions for the preparation of financial statements are: Accrual basis The financial statements are prepared under the accrual basis.