Answer to Question #279161 in Management for LIZIE

Question

 The accounting profession has for a long time relied on certain accounting conventions to guide accounting practice. Yet the application of the sane conventions has been the source of criticism of the quality and relevance of information contained in financial reports.

Some of these conventions include:

(a)      The business entity principle.

(h)      The historical cost principle.

(c)      The monetary principle.

(d)      The matching principle.

(e)      The conservatism principle.

 Required:

For each of the principles listed above:

(a) Explain its meaning.                                                                                               (5marks)

(b) Justify its use.                                                                                                           (5 marks)

(c) Explain any weaknesses associated with its use.                                                   ( 4marks)

Answer 1

The business entity concept states that the business is separate from the owner(s) of the business. Therefore the accounting records for even the simplest business, the sole trader, must be kept separate from the personal affairs of the owner or owners.

One of the disadvantages of the business entity concept in accounting is that company owners must be very careful to keep detailed and accurate financial records, particularly of their expenditures. All personal and business expenses must be kept separate.

The historical cost principle is a basic accounting principle under U.S. GAAP. Under the historical cost principle, most assets are to be recorded on the balance sheet at their historical cost even if they have significantly increased in value over time. Not all assets are held at historical cost.

The disadvantage of Historical Cost Principle:

By using this concept, the users will get confusing especially when the market value of assets or liabilities are significantly different from original costs.

The monetary unit principle states that business transactions should only be recorded if they can be expressed in terms of a currency. In other words, anything that is non-quantifiable should not be recorded a business' financial accounts.

Weakness: Conflicting Goals

In a growing economy, with lower unemployment, inflation may increase temporarily. This triggers monetary policy action to slow growth and reduce inflation. When inflationary pressures decrease, the jobless rate may rise for a brief period as the pace of the economy slows.

the matching principle instructs that an expense should be reported in the same period in which the corresponding revenue is earned, and is associated with accrual accounting and the revenue recognition principle states that revenues should be recorded during the period in which they are earned.

The greatest disadvantage of matching is that the effect of matching factor on the occurrence of the disease of interest cannot be studied anymore. One should therefore limit matching to factors that are already known to be risk factors for the studied outcome.

The conservatism principle is the foundation for the lower of cost or market rule, which states that you should record inventory at the lower of either its acquisition cost or its current market value.