Question

Name the assumptions underlying generally accepted accounting principles. Comment on the validity of the stable unit of measurement assumption during periods of high inflation. Explain and provide examples.

Answer 1

(note - Don't think answer is lengthy it was break into points for your better clarification and explanation with appropriate Examples..)

• Assumption are underlying accepted accounting principle is --

(I)- Economic entity

(ii) -Periodicity

(iii) -Going Concern

(iv) -Stable monetary unit

{underlying assumptions or concepts of accounting:}

•The assumption of stable unit in accounting has necessitated the examination of historical cost assumption. The changes in level of the prices has put forward suggestions that accounts must be incorporated to reflect the effect of price level changes. The effect can be reflected through creation of reserved, revaluation of assets among others. Recording the assets at the original cost shows incorrect value of the financial items and may perplex the users decision. The changes in the monetary values has led to the FASB consider inflation accounting.

(I)- Economic entity assumption:

The business is separate from its owners and the economic activity can be identified with a particular level of accountability. Only transactions relating to the business are recorded in the accounts.

•Examples of economic entities are hospitals, companies, municipalities, and federal agencies. The "Economic entity assumption" states that the activities of the entity are to be kept separate from the activities of its owner and all other economic entities.

(ii) -Monetary Unit assumption:

It assumes that the money is the common denominator as the basis for recording accounting transactions ,measurement and analysis. It is useful in making prudent economic decision and better communication of financial results to the investors.

•let us understand with example -

• The CEO of Fine Enterprise delivers a lecture to the employees in a special meeting that can be helpful in raising the employees’ morale and completing the current projects on time.

As the value of the lecture cannot be measured in terms of money, it cannot be recorded in the books of accounts of Fine Enterprise.

(iii) -Going concern assumption:

Its presumes that the business will have long life and continue to exist in the foreseeable future. Only if the liquidation of the business is unavoidable this assumption stands invalid.

Example-

The going concern assumption reinforces the matching principle, which states that revenues and expenses need to be accounted for in the period at which they are earned or incurred.

(iv)- Periodicity assumption:

This assumption states that the economic activities can be divided into time periods like monthly, quarterly, yearly etc. The shorter the accounting period the greater the difficulty in preparing accounts.

•taking some examples for your better understanding...

The Meta company provides services valuing $2,500 to Beta company during the first quarter of the year. The Beta company will pay the cash for these services next quarter. According to time period assumption, if Meta company prepares its financial statements at the end of the first quarter of the year, it must include this service revenue of $2,500 in its income statement for the first quarter.

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