At the end of an accounting year (or other accounting period), an accountant or bookkeeper will make adjustments to various ledger account balances. The adjustments we will examine in this section are accruals, prepayments, inventories and doubtful debts.
The above mentioned adjustments are examples of how two accounting concepts, namely the accruals concept and the prudence concept affect how accounts are prepared.
Accounting concepts (sometimes referred to as accounting principles) are the general rules or guidelines that accountants use when preparing a business financial books and accounts. There are numerous accounting concepts and the accruals and prudence concepts are described below:
The Accruals Concept
The accruals concept is probably the most far-reaching of the accounting concepts and the vast majority of financial statements can be described as being prepared using the accruals basis of accounting (those that aren’t are usually very small business that have prepared their accounts on a cash basis).
The accruals concept tells us that transactions should be recorded in the periods in which they actually take place. In earlier sections we have already seen examples of how this affects the way that transactions are recorded:
- When items are sold or purchased, we record the transaction when they take place and not when the associated sales receipt or purchase payment is made
- The cost to the business of its property, plant and equipment is depreciated – which matches its cost with the periods in which the business benefits from its ownership
The Prudence Concept
The prudence concept tells accountants and bookkeepers to be cautious in the way that financial statements/accounts are prepared and ensure that:
- Income and assets are not overstated in value
- Expenses and liabilities are not understated in value