Recognition and measurement concepts is the Third level of the frame work consists of concepts that implement the basic objectives of level one. These concepts explain which, when, and how financial elements and event should be recognized, measured, measured and reported by the accounting system.
This level can be broadly classified into three groups namely:
Fig: Recognition and measurement concepts
Assumptions include the following four accounting concepts:
1.Economic entity/Business entity assumption:
Economic entity assumption means that the entity of the business is separate from the entity of the owner. In other words, it means that economic activity cab be identified with a particular unit of accountability. simply speaking, separate set of books should be maintained for a business as a separate economic entity. Sole proprietor, firm or company is example of entity. This show the limits as to what information should be included in the financial statements of a given entity. for reports and decisions to be effective, business must follow this assumption. So business entity assumption reflects two things:
a) a business is accounted for separately from its owner or owners.
b) We account for each business separately that is controlled by the same owner.
2. Going concern assumption:
It is also known as the ‘continuing-concern’ assumption. In general, accounting believes that the business entity is a going concern meaning that the business entity will continue to operate for an indefinite period of time, at least long enough to carry out its existing plans and contracts. Simply to say, it has a long life, it is not expected to be liquidated. the going concern is not applicable in case of liquidation only. In contrast, a project has expected life, not the business.
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In absence of the assumption, plant assets should be stated at their liquidation value (selling price less cost of sale), not at cost price. In that case, depreciation and amortization of these assets is not needed. Again, classified balance sheet and classified. Income statement preparation becomes difficult (As current and long-term classification of assets and liabilities is not material).
Note to the readers:
Business entity must mention in the notes to financial statements whether it is a going concern or not if it is not expected to be liquidated or if its existence as a going concern is subject to bankruptcy. Bexmico Pharmaceuticals ltd. in 2003 reported in the annual report as to going concern assumption like:
“Directors are convinced after making appropriated enquirers at the time of approving the financial statements that the company has adequate resources to carry out its operational existence for the foreseeable future. It is therefore appropriate to adopt going concern basis to preparing the financial statements.”
3. Monetary unit assumption:
Monetary assumption means that business transactions events or accounting information is measured in terms of money. It provides an appropriate basis for accounting treatment and analysis. If accounting transactions are measured in different units. the entity cannot display its financial position and operating result.
In the regard accounting generally assumes a stable monetary unit meaning the value money $ USD in terms of its ability to purchase certain goods or services is constant over time. It ignores inflation (price change) in accounting records. under this concept, we assume that the changing prices have no impact on financial figures that are already recorded.
In absence of this assumption, accounting can’t communicate information to the uses effectively. Again, users cannot compare the operating results of an entity with that of another entity and make decisions effectively.
Accounting measurement unit differs from country to country as follows:
- The efficient executive of business entity switched to another business. We have substantial loss. But it can’t be measured in terms of money. so it’s not recorded in accounting books.
- A business owns USD $30,000 of cash, $6,000 tons of raw materials and 5 trucks. These amounts cannot be added together to produce a meaningful total of what the business owns. As different units of measure are there.
Recognition and measurement concepts Every transaction is to be measured in terms of money. but every measurable event may not be necessarily recorder in the books. Because to be transaction, every event must satisfy at least two criteria. It is to be measured in terms of money and it must bring a change in financial condition of the entity. for instance, placing an order to purchase goods USD $ 10,000 is not a transaction. As it is measured in terms of money, but does not change the entity financial condition.