What are the key accounting assumptions in financial statements?
There are a handful of key assumptions and principles used to define accounting, which provides the structure for how a business “accounts” for the financial transactions and results of the business.
1) Economic entity: This assumption relates to the idea that all activity in the financial statements relates only to the legal entity and does not include activity from other businesses or personal transactions of the owners.
2) Monetary unit: The monetary unit principle assumes that money (e.g. US dollar) is the primary unit of measurement and that all transactions and/or economic events will be measured in a form of currency.
3) Going concern: Financial statements are required to be prepared under the “going concern” basis of accounting, which means that unless otherwise stated, management does not see any major risks that would cause the entity to not continue to operate into the future.
4) Periodicity: The periodicity assumption means that a company’s economic activities can be divided into relevant reporting periods (annual, quarterly, monthly).
5) Matching principle: This is basically addressing the fact that revenue and expenses should be recognized in the period they are earned or incurred. This more commonly known as the accrual method, which is required by U.S. GAAP.
6) Qualitative characteristics: These characteristics include comparability, verifiability, timeliness, and understandability. These characteristics enhance the usefulness of information in order for the financial information to be relevant and faithfully represented.
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