History: before 3000BC the people of Uruk and other Mesopotamian cities used clay tablets to record financial transactions.
The Fundamental Conventions:
- Money measurement: A record of facts that can be expressed only in monetary terms. A useful common denominator when comparing apples with rental agreements
- Business entity: The accounts are kept for the purposes of the enterprise and not the owner. If the owner were to lend some of the enterprises money, it would appear as a liability, even though the owner may consider it his own.
- Cash & Accrual Accounting: two differing methods of keeping track of all enterprise transactions.
- Cash: This method tells you when and how much cash changed hands. Popular with small businesses. When a small enterprise purchases a power tool, it is posted in full at the point of purchase, rather than over the course of its useful life.
- Accrual: Income and expenses are recorded as they occur, regardless of whether or not cash has actually changed hands. An excellent example is a sale on credit. The sale is entered into the books when the invoice is generated rather than when the cash is collected. Likewise, an expense occurs when materials are ordered or when a workday has been logged in by an employee, not when the check is actually written. The downside of this method is that you pay income taxes on revenue before you’ve actually received it.
- Objective cost concept: Assets are entered into the accounts at the cost at date of purchase. This removes subjective opinions of an objects estimated worth, that may differ amongst people. The Balance sheet does not show current worth or value of a business. Depreciation is how we show an asset being consumed over its working life.
- Going Concern: It is assumed that the enterprise will continue to trade indefinitely. This means that all assets are looked at simply as profit generators and not as being available for sale. This brings us back to depreciation will list the value as “Book” value, the resale value may be much higher if it were to be sold.
- Conservatism: Accounting records contain only measurable and verifiable properties, debts, sales and costs. Often doom laden, the accountant will always choose the lower of two possible end profits, and higher of two possible expense figures. Few people are upset if the profit figure is higher or the loss figure is lower at the ned of the financial year. The converse is never true