Accounting Concepts and Conventions

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A1 - Accounting Concepts and Conventions


There are some important concepts which are taken for granted in preparing accounts. A statement of accounting practice (SSAP 2 Disclosure of accounting Policies) describes 5 concepts as fundamental accounting concepts: they are;

  • Prudence
  • Accruals
  • Going Concern
  • Consistency
  • Materiality

The Prudence Concept:

Very often an accountant has to make a choice as to which figure he will take for a given item. The Prudence concept means that normally he will take the figure which will understate rather than overstate the profit. Alternatively, this could be expressed as choosing the figure which will cause the capital of the firm to be shown at a lower amount rather than at a higher one. This could be said to be to make sure that all losses are recorded in the books, but that profits should not be anticipated by recording prematurely.

For example, cookers of Hotpoint are stated in their balance sheet at their actual cost £150 rather than their selling price of £200. This is simply the aspect of the prudence concept; to value the machines at £200 would be to anticipate making a profit before the profit has been realised.

The other aspect of the prudence concept is that where loss is foreseen, it should be anticipated and taken into account immediately. If a purchases stock for £1250 but because of a sudden slump in the market only £950 is likely to be realised when the stock is sold. The prudence concept dictates that the stock should have been valued at £950. It is not enough to wait until the stock is sold, and then recognise the £300 loss; it must be recognised as soon as it is foreseen. For example, if Bosch bring out a state of the art washing machine Hotpoint may lower its asking prices so they can compete with a new model.

A profit can be realised to be a realised profit when it is in the form of:

  • Cash
  • Another asset which has a reasonably certain cash value, this includes debtors from what they owe.

The SSAP 2 quotes:

“Revenue and profits are not anticipated, but are recognised by inclusion in the profit and loss account only when realised in the form of either cash or of other assets, the ultimate cash realisation of which can be assessed with reasonable certainty; provision is made for all known…..expenses and losses whether the amount of these is known with certainty or is best estimate in the light of information.”

This concept led accountants into being portrayed as being rather miserable by nature; they were used to favouring looking on the dark side of things and ignoring the bright side. However, the concept has seen considerable changes in the last few decades, and there has been a shift along the scale away from the gloomy view and more towards the desire to paint a brighter picture when it is warranted. An example of the ‘Prudence Concept’ is the provision for bad debts:


Where an expense such as a bad debt is matched in the same period with revenue from the sale, then all is in order for the purposes of net calculation. However, it is very often the case that it is not until a period later than that in which the sale took place is it realised that the debt is a bad debt. Therefore, to try to bring into the period in which the sale was made a charge for bad debts resulting from such sales, the accountant brings in the concept of an estimated expense. Such an item of expense for an expense that had taken place, but which cannot be calculated with substantial accuracy is known a provision. The item of estimated expense for bad debts is therefore known as a provision for bad debts. In addition writing of debts are irrecoverable. It is necessary as a matter of business prudence, to change the Profit and Loss Account with the amount of the provision for any debt, the recovery of which is in doubt:

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Company begins trading and sells goods worth £100,000.

There are outstanding debts of £15,000. Of these debts the

company is doubtful if £6,000 will ever be paid.

The company make a ‘Provision for bad debts’ of £6,000. Sales will

be shown in the profit and loss account at their full value of £100,000

but the provision for bad debts will be charged at £6,000. Due to the

uncertainty of sales not being realised, the prudence concept suggests

that the £6,000 should not be included for the profit of the year.

The Accruals Concept:

The definition which ...

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