Solution 13.3

Accounting concepts are broad basic assumptions, which form the basis of the financial accounts of a business. They help ensure transactions are recognised and measured on a uniform basis. 

The Accruals Concept requires that the effects of transactions should be accounted for when they occur and are included in the statements for the periods they relate to.  The accruals concept requires two things

1.    When calculating net profit, expenses should be matched against related revenues.

2.    Net profit is the difference between revenues earned (not necessarily received) and expenses charged (not necessarily paid).  

The Realisation Concept clarifies when a business accounts for a transaction and thus the related profit or loss on the transaction. Effectively the realisation concept tells us when to recognise the profits or loss on a transaction. It states that profits or losses on transactions can only be accounted for when realisation has occurred. 

Materiality Concept recognises that some transactions are not sufficiently important to waste time and effort in ensuring the correct accounting treatment. Information is considered material if its omission or misstatement could influence the economic decisions of the various user of account. The deciding factor is, if the cost of accounting for a transaction in the correct manner is greater than the value of the transaction, then the amount in question would not be considered material 

The Substance over Legal Form Concept states that if the legal aspect of a transaction is different to the substance of the transaction then the substance of the transaction takes precedent over the legal form. In other words we account for the substance (economic reality) of the transaction, not the legal aspect of it. This concept helps to restrict companies from window dressing their balance sheet and profit and loss account through the use of ‘off balance sheet finance’.