Basic Concepts

Basic concepts

The establishment of concepts is very important to the development of a theoretical framework. Accounting concepts have been given terms which are used to describe the events that comprise the existence of business of every kind. It is for this reason that accounting is often characterized as 'the language of business'. The basic concepts provide the essential material of accounting theory.

Assets are things of value which are possessed by a business. In order to be classified as an asset the money measurement convention demands that a thing must have the quality of being measurable in terms of money. The assets of a business comprise not only cash and such property as land, buildings, machinery and merchandise, but also money which is owed by individuals or other enterprises (who are called debtors) to the business.

Liabilities are the debts of the business. Most firms find it convenient to purchase merchandise and other items on credit rather than pay cash at the time of purchase. This gives rise to liabilities in the form of trade creditors. Creditors originate also when a firm borrows money as a means of supplementing the funds invested by the owner. The reason why amounts of money owed to the creditors by a business are known as liabilities is that the business is liable to the creditors for the sums noted.

Capital is the excess of assets over liabilities and represents the owner's claim against the business. If we know the total assets and the total liabilities we can find the capital by subtraction. As we will illustrate in Part 2, the assets of a business must always be equal to the liabilities and the owner's capital. This is the result of double-entry book-keeping, whereby each transaction has a two-fold effect in its accounting treatment.

Revenue is earned by a business when it provides goods and services to customers. Whereas a trading business will derive revenue mainly from the sale of merchandise, a business that renders services, such as a garage, will derive revenue as a result of charging for the service. It is not necessary for a business to receive cash before recognizing that revenue has been earned. The accrual convention recognizes revenue which arises from the sale of goods or services on credit.

Expenses are incurred in earning revenue. Examples of expenses are the salaries paid to employees and the rent paid to the landlord. When expenses are not paid for at the time they are incurred but are to be paid for at some future time the amount of such expenses is recorded as a liability.

Income results when the total of the revenue of a business for a certain period of time, such as a year, exceeds the total of the expenses for that period. As we will see in Part 2, income accrues to the owner of the business and increases his claim against the business. The increase is reflected in the capital of the business.

Transactions are events which require recognition in the accounting records. They originate when changes in basic concepts are recorded. A transaction is financial in nature and is expressed in terms of money.


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Read on: Approaches to the Development of Accounting Theory

Approaches to the development of accounting theory

Several approaches to the development of accounting theory have emerged in the last two decades. These approaches may be identified as follows:

1. Descriptive

2. Normative general

3. Decision-making

Empirical

Normative specific

4. Welfare

The descriptive approach

Theories developed using the descriptive approach are essentially concerned with what accountants do. In developing such explanations, descriptive theories rely on a process of inductive reasoning,... see: Approaches to the Development of Accounting Theory