Assumptions, Principles and Constraints in Accounting

Explanation

Content Standard 1.4 introduces the conceptual framework of accounting, namely the assumptions (andaian), principles (prinsip) and constraints (batasan) that underpin the preparation and reporting of accounting information. All transactions are recorded and reported using uniform guidelines so that the financial statements produced are reliable, comparable and understandable to users such as owners, creditors and authorities. Without this framework, every business would record transactions using its own methods and financial information would become inconsistent and misleading.

There are four main assumptions in accounting. First, the Separate Entity Assumption (Andaian Entiti Berasingan) treats the business as an entity separate from its owner, so the owner's personal transactions must not be mixed with the business transactions. Second, the Going Concern Assumption (Andaian Usaha Berterusan) assumes the business will continue to operate for an indefinite period in the future, so assets are recorded at cost and not at immediate sale value. Third, the Accounting Period Assumption (Andaian Tempoh Perakaunan) divides the life of the business into equal periods (usually one year) so that performance can be measured and reported periodically. Fourth, the Money as a Measure Assumption (Andaian Wang Sebagai Ukuran) states that only transactions that can be valued in money (for example Ringgit Malaysia) are recorded, while matters such as staff skill or morale are not recorded because they cannot be measured in money.

In addition to the assumptions, there are six important principles. The Consistency Principle (Prinsip Ketekalan) requires a business to use the same accounting method from one period to the next so that financial statements are comparable; if the straight-line depreciation method is used this year, the same method should continue next year. The Cost Principle (Prinsip Kos) requires assets to be recorded at the actual cost paid at acquisition and not at an estimated value. The Revenue Recognition Principle (Prinsip Pengiktirafan Hasil) requires revenue to be recognised when it is earned (goods are sold or services rendered), not necessarily when cash is received, while the Expense Recognition Principle (Prinsip Pengiktirafan Belanja) requires expenses to be recognised when they are incurred. The Matching Principle (Prinsip Pemadanan) requires expenses to be matched against revenue in the same accounting period so that net profit is calculated accurately, which is why adjustments such as accrued expenses and revenue received in advance are made.

Two further principles are the Materiality Principle and the Prudence or Conservatism Principle. The Materiality Principle (Prinsip Materialiti) allows items of small value that do not affect users' decisions to be recorded in a simplified way; for example the purchase of a broom or a waste basket may be recorded directly as an expense even though it can be used for more than a year. The Prudence or Conservatism Principle (Prinsip Berhemat atau Konservatisme) requires a business not to overstate assets and revenue or understate liabilities and expenses; profit is not recognised until it is earned, but anticipated losses must be taken into account, for example by making a provision for doubtful debts and valuing inventory at the lower of cost or net realisable value.

Constraints (batasan) refer to the limits of accounting information. For example, financial statements focus on information that can be measured in money, so they ignore qualitative factors such as reputation and customer satisfaction. Accounting information is also historical in nature because it reports transactions that have already occurred and may not reflect current conditions due to changes in the value of money or inflation. Furthermore, preparing very detailed information involves cost and time, so there is a trade-off between the cost and the benefit of information. Understanding these constraints allows users to interpret financial statements more cautiously and not to rely entirely on the reported figures.

Worked examples

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Key terms

Separate Entity Assumption (Andaian Entiti Berasingan)

The assumption that the business is an entity separate from its owner, so the owner's personal transactions are not mixed with the business's.

Going Concern Assumption (Andaian Usaha Berterusan)

The assumption that the business will continue to operate for an indefinite period, so assets are recorded at cost rather than immediate sale value.

Matching Principle (Prinsip Pemadanan)

The principle requiring expenses to be matched against revenue in the same accounting period so that net profit is calculated accurately.

Prudence or Conservatism Principle (Prinsip Berhemat)

The principle requiring a business not to overstate assets and revenue nor understate liabilities and expenses when there is uncertainty.

Source: DSKP KSSM Prinsip Perakaunan Tingkatan 4

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