May 16, 2022/ Steven Bragg
Key accounting assumptions state how a business is organized and operates. They provide structure to how business transactions are recorded. If any of these assumptions are not true, it may be necessary to alter the financial information produced by a business
and reported in its financial statements. These key assumptions are: Accrual assumption. Transactions are recorded using the accrual basis of accounting, where the recognition of revenues and expenses arises when earned or used, respectively. If this assumption is not true, a business should instead use the cash basis of accounting to develop financial statements that are based on cash flows. The latter approach will not result in financial
statements that can be audited. Conservatism assumption. Revenues and expenses should be recognized when earned, but there is a bias toward earlier recognition of expenses. If this assumption is not true, a business may be issuing overly optimistic financial results. Consistency assumption. The same method of accounting will be used from period to period, unless it can be replaced by a more relevant method. If this assumption is not true, the
financial statements produced over multiple periods are probably not comparable. Economic entity assumption. The transactions of a business and those of its owners are not intermingled. If this assumption is not true, it is impossible to develop accurate financial statements. This assumption is a particular problem for small, family-owned businesses. Going concern assumption. A business will continue to operate for the foreseeable future. If this
assumption is not true (such as when bankruptcy appears probable), deferred expenses should be recognized at once. Reliability assumption. Only those transactions that can be adequately proven should be recorded. If this assumption is not true, a business is probably artificially accelerating the recognition of revenue to bolster its short-term results. Time period assumption. The financial results reported by a business should cover a uniform and
consistent period of time. If this is not the case, financial statements will not be comparable across reporting periods. Though the preceding assumptions may appear obvious, they are easily violated, and can lead to the production of financial statements that are fundamentally unsound. When a company's financial statements are audited, the auditors will be looking for violations of these accounting assumptions, and will refuse to render a favorable opinion on the statements until any issues found are corrected. Doing so will require that new financial statements be produced that reflect the corrected assumptions. ASSUMPTIONS OF FINANCIAL ACCOUNTINGThere are four basic assumptions of financial accounting: (1) economic entity, (2) fiscal period, (3) going concern, and (4) stable dollar. These assumptions are important because they form the building blocks on which financial accounting measurement is based. Some are reasonable representations of the real world, and others are not. As each assumption is discussed, try to understand why it has evolved, and be especially aware of those that fail to capture the world as it really is. Economic Entity AssumptionThe most fundamental assumption of financial accounting involves the object of the performance measure. Should the accounting system provide performance information about countries, states, cities, industries, individual companies, or segments of individual companies? While it is important that each of these entities operate efficiently, financial accounting has evolved in response to a demand for company-specific measures of performance and financial position. Consequently, financial accounting reports provide information about individual, profit-seeking companies. The process of providing information about profit-seeking entities implicitly assumes that they can be identified and measured. Individual companies must be entities in and of themselves, separate and distinct from both their owners and all other entities. This statement represents the economic entity assumption, the first basic assumption of financial accounting. This assumption ... The IASB bases its financial reporting standards on the conceptual framework that it adopted in 2010. The conceptual framework was developed by IASB and it lays down the basic concepts and principles that act as the foundation for preparation and presentation of the financial statements. The framework is also used as guide to develop / improve standards and to resolve any accounting conflicts. Note that the conceptual framework is not an accounting standard in itself and cannot be used as an alternative to the financial reporting standards applicable in your country. The IFRS framework addresses the following:
Objectives of the Financial Statements In very simple words, the objective of Financial Statements is: “To provide useful information to the users.” Let's look at this statement more closely. There are three keywords here: Useful: The useful here refers to the need for financial statements to be able to provide high quality information to the users. The usefulness is described in the form of the qualitative characteristics of the financial statements. Information: This refers to what information should the financial statements provide. This includes financial position, financial performance, and changes in financial position. These three tips of information are provided in the three financial statements, namely, balance sheet, income statement, and statement of cash flow. Users: This refers to the end users of financial statements such as investors, lenders, employees, government, customers, vendors, etc. Underlying Assumptions of IFRS There are two fundamental assumptions underlying the financial statements: Going Concern, and Accruals. Going Concern: Here the idea is that the business will continue to operate for the forceable future. This is a really important assumption because if it was so that the business will close by the end of the year, then all the assets will have to be sold and their sale value would have to be recorded in the books. However, this is not the case and businesses use their assets and resources for many years. Accruals: The second important assumption is the accrual principal according to which we match any income and expenses to the period in which they were earned or incurred not in the period in which the payment was received or made. Qualitative Characteristics of Financial Statements The conceptual framework sets out four qualitative characteristics of financial statements:
So, to be useful, the information on financial position, financial performance, and changes in financial position should be understandable, relevant, reliable, and comparable. Elements of Financial Statements The framework lists five elements of financial statements:
We see the assets, liabilities, and equity in the statement of financial position (Balance Sheet), and we see the income and expenses in the statement of financial performance (Income Statement). Recognition of the Elements of Financial Statement Along with the five elements, the framework also provides guidelines about when these elements are recognized in the financial reports. To be recognized, an item must meet the definition of an element, and satisfy the following criteria:
Measurement of the Elements of Financial Statement The final part of the framework describes how we should measure an item once it has been recognized. It suggests the following conceptual models:
Among these, historical cost is the most commonly used measure. Note that the IFRS framework does not provide which measurement model should be used for a particular element. Such details are provided in the reporting standards. What is the underlying assumption mention 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.
What is the underlying assumption of the Conceptual Framework?Going Concern Basis. The going concern basis of accounting is the assumption in preparing the financial statements that an entity will continue in operation for the foreseeable future and does not plan to go into liquidation, and will not be forced into liquidation or to curtail its operations.
What is the underlying assumption for financial statements?The financial statements are normally prepared based on the assumption that operations of an enterprise will continue in the foreseeable future, i.e. neither there is any need nor any intention to materially curtail/ reduce the scale of operations or level of activities.
Which of the following assumptions underlie the framework for the presentation and preparation of financial statements?The four basic assumptions that form the basis of financial accounting structure are business entity assumption, accounting period assumption, going concern assumption, and money measurement assumption.
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