ACCOUNTING

Accrual Concept & Prudence Concept

Accrual Concept & Prudence Concept

Introduction

Financial accounting of the businesses hold immense importance as they provide significant economic information based on which company makes its decisions. Financial accounting of businesses involves certain rules and guidelines that facilitate management and reporting of company's financial standing. These rules and guidelines are usually referred to fundamental accounting concepts that are established by the IAS and GAAP in Financial Reporting Standard (18), as the broad fundamental assumptions that underlies the periodic financial accounts of the business firm (FRC, 2013, n.d). Among these accounting concepts/principles, there are two significant concepts: accrual concept and prudence concept. These two concepts impacts on the profitability realization of the business and therefore holds importance. The illustration of these two important accounting concepts and its effect on profitability of the firm is provided in this paper.

Discussion

Accrual Concept

Accrual basically refers to something that becomes due particularly an amount of money which is still required to be paid or collected at the end of the accounting period. This means that revenues are recognized when they become receivables. Thus, in accrual concept accrual accounting is used i.e. revenues are recognized at the time of sale and expenses as they incurred, although the cash payment and receipt occur at different time or in another accounting period. Both transactions records in the accounting period to which they relate. As a result, the accrual concept creates a difference among the accrual receipts of cash and the right to collect cash as regards revenue and actual disbursement of cash and liability to pay cash as regards expenses. Hence, this concept describes the profitability of the firm as a surplus of earnings over disbursements of the given accounting period (Chakravarty, 2002, p.13).

In accrual concept under financial accounting assumes that profit is realized at the point of sale of product or service regardless of the fact that cash is not received yet. For instant, a company sold a product of $4500 on 24th March 2004 and the payment is not collected until 9th May, the payment is due and will be paid to the company on the date of sale i.e. 24th March 2004. In this case, if the accrual system is used, then the amount should be incorporated in the revenue for the year ending 31st March 2004. Likewise, expenses are recognized when the services are offered, regardless of the fact that actual payments for those services are not yet made. For instance, when a company collects items costing $18000 on 25th March 2004 but the payment of these items is made on 3rd May 2004, the accrual system asks for recording the expenses for the year ending on 31st March 2004, even though the payments has not been paid until 31st March 2004, yet the service is received by the person and the individual to whom obligation is paid is represented as creditor.

Thus, in short, accrual concept asks for recognizing a revenue when it realized and similarly expenses are required to be ...