At the time of preparing financial statements of a company, there are some fundamental accounting assumptions. In case if they are not mentioned, it will be presumed that these accounting assumptions are followed in the financial statements.
So let us discuss these fundamental accounting assumptions in brief:
Fundamental Accounting Assumptions
There are three fundamental accounting assumptions that are presumed to be followed in every accounting transactions of an entity. Howsoever, it is not important that the business has followed these fundamental accounting assumptions. In a case, if a business does not follow these assumptions then the company shall disclose all the relevant financial transactions, together with the financial statements.
According to the accounting standard of India, here are the 3 fundamental accounting assumptions:
Going concern is an assumption that an entity has no plan of winding up in the nearer future at the time of preparing financial statements. In other words, the entity will continue to exist indefinitely or it will be a going concern.
An example of the going concern concept of accounting is the depreciation computation on the basis of fixed assets life rather than their current market value. The entity presumes that it will be a going concern and they will consume their assets until it is fully depreciated.
Another example of going concern is the writing off the deferred expense. The benefit of such expenses is enjoyed through different years instead of utilizing the expense in a single year. This is too conceivable because of going concern fundamental accounting assumption.
As per the consistency accounting assumption, it is assumed that an entity is following the same concept until the changes are mentioned in the accounting policies, standards and so forth. Consistency assumption helps the company to have uniform financial statements. This consistency helps the user of financial statement to compare the different period’s financial statements.
It becomes easy for the user of financial statement to analyze its performance when the accounting methods remain the same for different periods. It also helps the management in plan formulations and decision making.
However, this doesn’t imply that an entity cannot change its method of accounting. Here are some of the situation where an entity has to change its accounting methodology or policy:
- Statutory requirement
- Change in accounting method or policy will help them to show a better view of accounts
Moreover, for any change in accounting policy or method the user of the financial statement shall disclose the reason behind such change.
As per the accrual fundamental accounting concept all the accounting transactions are recorded in the books of accounts once they are accrued irrespective the actual cash is received or not. As per the accrual concept, the income and expenditure are recorded in the year they are accrued.
Let us understand this with an example:
- ABC is a company
- They carried out credit sales in the month of December 2018, 50,000 INR.
- On 15th March 2019, they 35,000 INR and 15,000 INR still has to be received.
- So in such a case, the entire 50k INR will be realized in the year 2018-2019, irrespective of cash received.
In a similar way expense shall be realized in the same year in which they are incurred, irrespective whether the payment was made or not.