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T2_Assumptions & Characteristic_Theory

Rita Fontanella

TOPIC 2

Accounting Conceptual Framework

The following Accounting Assumptions and Qualitative Characteristics are applied when preparing a Balance Sheet.

Accounting Assumptions

The Accounting Entity is the key Accounting assumption applied when preparing a Balance Sheet.

Accounting Entity

The Accounting Entity assumption states that:

The records of assets, liabilities and business activities of the entity are kept completely separate from those of the owner of the entity as well as from those of other entities.

Below are three examples of how to apply the Accounting Entity assumption.

1. If the owner contributes assets to the business this should be recorded and reported as Capital.

2. If the owner withdraws (takes out) assets from the business for personal use this should be recorded and reported as Drawings.

3. Transactions between the business and the owner are reported in the Owner’s Equity section of the Balance Sheet.

Qualitative characteristics

Relevance and Faithful Representation are two qualitative characteristics that are applied when preparing a Balance Sheet.

Relevance

In accounting, the qualitative characteristic of Relevance states that

Financial information must be capable of influencing decisions made by users to help them make predictions and/or confirm or change their previous evaluations.

Relevance is a guide to what information should be included or excluded when preparing financial reports. If the information influences decision-making about the business, then it is considered to be relevant and should be included in the reports.

Below are two examples of the application of Relevance.

1.Personal assets and liabilities of the owner should not be reported in the Balance Sheet of the business as they will not influence decision-making related to the business.

2. Contributions or withdrawals of assets from the business by the owner should be reported as they will influence decision-making.

*Note: Relevance is supported by the Accounting Entity Assumption.

Faithful representation

In accounting, the qualitative characteristic of Faithful representation states that

Faithful representation states that financial information must be a truthful representation of the real-world economic event and is complete, free from material errors and without bias.

What does this mean?

*Complete means the information should include all the necessary details for users to understand what occurred

*Free from material error means the information should be accurate and can be checked or verified

* Without bias means the information is not based on personal opinions or estimates and can be verified with a source document

 

Below is an examples of the application of Faithful Representation.

Stock (asset) is valued at its original purchase price rather than its selling price, as the selling price is an estimate and is not free from error or bias.