What is a basic underlying assumption in the preparation of financial statements?

• The Consistency Assumption
• The Going Concern Assumption
• The Time Period Assumption
• The Reliability Assumption
• The Economic Entity Assumption

Students who have earned an accounting degree will learn that accounting assumptions ensure that businesses both large and small operate smoothly, efficiently, and according to the standards set by the Financial Accounting Standards Board. When these assumptions are not followed, it can often lead to financial statements that are unsound. While there are several accounting assumptions that businesses will want to follow, the following five assumptions described below are considered to be some of the most important.

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1. The Consistency Assumption

One key accounting assumption is known as the consistency assumption. Under this assumption, it is important that companies make sure that they use the same accounting method across all accounting practices and accounting periods. The only exception to this assumption is the case in which a different method would be more relevant and efficient. Maintaining consistency in accounting methods will ensure that accounting records over several accounting periods can easily be compared.

2. The Going Concern Assumption

Another key accounting assumption that persons working towards an accounting degree will need to understand is the going concern assumption. This assumption assumes that the business in question will likely continue operating in the foreseeable future. It assumes that the company will not go bankrupt and will be able to meet its obligations and objectives. The going concern assumption presumes that the business will be operating beyond its next fiscal period, will complete its expected plans, and meet its projected goals.

3. The Time Period Assumption

According to the Financial Accounting Standards Board, another extremely important accounting assumption is the time period assumption. What this assumption means is that the accounting practices and methods used by a company should be maintained and reported for specific periods of time. These periods should also be consistent each year that the business is in operation. Time periods can be monthly, quarterly, biannually, or annually but must be consistent so that records can be compared over set time periods.

4. The Reliability Assumption

The reliability accounting assumption states that only transactions that can be proven should be recorded in accounting practices. And what this means is that businesses must be able to prove transactions through such things as receipts, billing statements, invoices, and bank statements. There must be some form of objective evidence of a transaction before the business can report it in its accounting records. This assumption is often known as the objectivity assumption.

5. Economic Entity Assumption

A key accounting assumption that is especially important for small businesses is the economic entity assumption. This assumption assumes that the accounting records of a business and the personal accounting records of the business’ owner will be kept separate. Business transactions should never be mixed with the business owner’s personal transactions in accounting practices. This issue is particularly problematic with small, family-owned businesses.

Accounting is a thriving field that is currently growing in demand. And for persons who would like to begin a career in this exciting field, they will need to learn about the five key accounting assumptions as described above.

What are Accounting Assumptions?

Accounting assumptions can be defined as a set of rules that ensures the business operations of an organization are conducted efficiently and as per the standards defined by the FASB (Financial Accounting Standards Board), which ultimately helps in laying the groundwork for consistent, reliable, and valuable information and it is based entirely on the fundamentals like accrual, consistency, reliability and objectivity, monetary unit assumption, business entity assumption, period, going concern, historical costs, full disclosures, and conservatism.

It defines the mechanism for reporting financial transactions in the financial statementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more. These are rules that make it mandatory for the companies to conduct their business operations and reporting mechanism as per the standards laid out by the FASB. The purpose of accounting assumptions is to provide a basis of consistency that the readers of the financial statements can use to evaluate the genuineness of a company’s financials and confirm its financial well-being depicted in the same.

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List of Accounting Assumptions

#1 – The Reliability Assumption

This assumption makes it mandatory for the companies to record only such accounting transactionsAccounting Transactions are business activities which have a direct monetary effect on the finances of a Company. For example, Apple representing nearly $200 billion in cash & cash equivalents in its balance sheet is an accounting transaction. read more that can be easily proven. In other words, financial transactions that can be verified through invoices, billing statementsBilling statement template makes it easy to generate the transaction receipts which can be easily printed, emailed to the customer any time. These could be implemented for billing invoices, customer account relationship management including general invoicing.read more, receipts, and bank statements must only be recorded in the financial statements.

#2 – The Consistency Assumption

This assumption makes it substantial for the companies to use a consistent method of accounting for all the accounting periods. Having a consistent method of accountingAccounting methods define the set of rules and procedure that an organization must adhere to while recording the business revenue and expenditure. Cash accounting and accrual accounting are the two significant accounting methods.read more will ensure an easy comparison between the company’s financial statements for different financial periods.

#3 – The Time Period Assumption

This assumption states that the accounting practices and methods used by an entity must be reported and maintained for a particular period. The companies must ensure that these periods remain consistent for each year. It becomes easy for the readers of the financial statements to compare the same for different periods. This assumption is also known as periodic or accounting period assumptionAccounting Period refers to the period in which all financial transactions are recorded and financial statements are prepared. This might be quarterly, semi-annually, or annually, depending on the period for which you want to create the financial statements to be presented to investors so that they can track and compare the company's overall performance.read more.

#4 – The Going Concern Assumption

Going ConcernAny analyst analyzing a company will be left to a basic assumption that the company does not go bankrupt or file a chapter 11 bankruptcy. This basic assumption allows the analyst to think that there is no immediate danger to the company. The company can operate until infinity is called the principle of going concern. is also termed a continuity assumption. Per this assumption, a company will continue to deliver its business operationsBusiness operations refer to all those activities that the employees undertake within an organizational setup daily to produce goods and services for accomplishing the company's goals like profit generation.read more and continue to exist for an unforeseeable future. This assumption is based on the fact that a company will never go bankrupt, and it shall be able to perform its business operations for a more extended period.

#5 – The Economic Entity Assumption

This assumption separates the owner of the company from the company itself. It means that the economic entity assumption separates the company’s financial records from that of the personal financial records of the company’s owner. In all probabilities, the commercial business transactionsA business transaction is the exchange of goods or services for cash with third parties (such as customers, vendors, etc.). The goods involved have monetary and tangible economic value, which may be recorded and presented in the company's financial statements.read more must not mix with the individual transactions of the company’s owner. This assumption is also known as the business entity assumption.

#6 – The Money Measurement Assumption

Money Measurement concept states that every worth transaction recording must be recorded and expressed in monetary terms. The money measurement assumption enhances the understanding of a business concern’s financial state of affairs.

Importance of Accounting Assumptions

• These assumptions are huge for the organization, its management, and the readers of the financial statements. It helps establish a robust framework for reliable and consistent information.
• It enhances the reliability, verifiability, and objectivity of financial statements. The purpose of such assumptions is to enable the users of the financial statements to evaluate and confirm the genuineness of an organization’s financial records and assess economic well-being. There is no doubt that these assumptions help in the establishment of credibility.
• It offers a systematic structure concerning how the accounting transactions of an organization for a particular financial period must be recorded and reported in the financial statements. The analyst and potential and existing investors can verify the accuracy, reliability, authenticity, and comparability of the financial statements for different accounting periods with the help of accounting assumptions.
• The users of the financial statementsFinancial statements prepared by the Companies are used by different categories of individuals and corporates on the basis of their relevancy to the respective parties. The most common users to the financial statements are Management of the Company, Investors, Customers, Competitors, Government and Government Agencies, Employees, Investment Analysts, Lenders, Rating Agency and Suppliers.read morecan even make significant investment-related decisions based on the genuineness, reliability, and financial results depicted in a company’s financial statements. It enables the management to make necessary decisions based on the results of the financial statements. It helps minimize or eliminate the presence of potential errors and frauds in the same.

Benefits

The benefits of accounting assumptions are reaped not just by the companies and their management but also by the investors. These benefits are as follows-

• These are beneficial for all kinds of investors, whether they are potential or existing ones. The investors can assess the genuineness of the company’s financial statements and accordingly determine the true and fair view of a company’s financial wellbeing. It enables the investors to make crucial investment-related decisions based on their reasoning. It saves them from being manipulated by false representations of the transactions in a company’s financial statements.
• These are beneficial for the management of an organization too. The management of an entity gets to know its actual wellbeing, and based on these results, the former can make appropriate decisions and ensure that the latter does better the next time.
•  It helps the companies attain their long-term and short-term business goals and objectives.

Conclusion

•   These are fundamental to the well-being of an organization. These assumptions lay the groundwork for how a financial transaction must be reported in the financial statements and make it mandatory for the companies to ensure complete adherence to all the statutory requirements.
• It highlights the reliability, authenticity, and reliability of an organization’s financial statements. These are beneficial for the company, its management, and the readers of the financial statements.

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