What Are the Basic Assumptions of Accounting?

by John Lister; Updated September 26, 2017
...

Accountants use a range of underlying concepts designed to ensure consistency when preparing company accounts. These include principles as to how accountants should treat the relevant financial data and conventions as to how they should deal with specific issues that may arise. But these are underpinned by four basic assumptions, which are effectively the fundamental basis of any set of accounts.

Assumptions

The four main assumptions accountants use are: A company is an entirely separate entity; a company is a going concern; a company's assets and liabilities are valued in a consistent unit of currency; and a company's lifespan can be split into equal accounting periods.

Details

Separate entity: The data in the company accounts should relate solely to the company and not include the private financial matters of any individuals. As part of this assumption, the accounts will clearly state the name of the business to which they relate.

Going concern: The business is currently in operation -- that is it is actively trading -- and that it will do so for the foreseeable future.

Units of currency: Everything listed in accounts is done so by an objective monetary value, that the currency used will be consistent (for example, U.S. dollars for a United States company) and that the value of this currency will remain relatively stable in terms of purchasing power.

Accounting period: The most common accounting period is the fiscal year, which most company accountants use as it is required of public companies in filings to the Securities & Exchange Commission. The fiscal year may coincide with the calendar year but does not have to.

Rationale

The separate entity assumption helps clearly distinguish those assets that belong to the company and those that belong to individuals, a distinction that is relevant in assessing the financial health of the company.

The going concern assumption allows the accountant to make estimates about how long assets will be used, which affects depreciation figures, and the way in which the accountant values income and expenses that have been accrued but not yet realized, such as when a company has sold goods but not yet received payment.

The currency units assumption is needed because if somebody values a business to come up with a sale price, the figures will include estimates for assets such as trademarks, brand names and customer goodwill. Because these do not have objective values, however, they cannot be included in company accounts.

The accounting period assumption is needed to allow a company's financial health to be tracked over time in a way that allows fair comparisons.

Exceptions

If there is specific evidence that the business has closed or will imminently cease trading, the accountant will not use the going concern assumption. Instead the accounts will value assets based on current resale value rather than follow a standard depreciation schedule.

Drawbacks

The currency unit assumption works on the basis that the currency unit will hold its value for the foreseeable value. This means accounts prepared on this assumption will not take account of possible future inflation or variations in the domestic value of income received in foreign currencies.

About the Author

A professional writer since 1998 with a Bachelor of Arts in journalism, John Lister ran the press department for the Plain English Campaign until 2005. He then worked as a freelance writer with credits including national newspapers, magazines and online work. He specializes in technology and communications.

Photo Credits

  • Jupiterimages/BananaStock/Getty Images