Accounting (9215) | General accounting concepts used in the preparation of accounting records

Welcome to the Foundation of Accounting!

Hi there! We are starting the vital section on the Development of the Accounting Model. This chapter might seem a bit theoretical, but these concepts are the fundamental rules—the DNA—of how we record financial information.
If you understand these four basic rules, the rest of the course (especially double-entry bookkeeping) will make perfect sense. Don't worry if this seems tricky at first; we'll use simple analogies to make sure every concept sticks!

Ready to build a strong foundation? Let's dive into the core concepts used when preparing accounting records.

1. The Business Entity Concept (The Separation Rule)

This is arguably the most important concept in all of accounting.

What does it mean?

The Business Entity Concept states that the business must always be treated as completely separate and distinct from its owner(s).

• The business is an entity (a separate thing) in its own right.
• We record transactions from the perspective of the business, not the owner.

The Analogy: The Business is a Separate Person

Imagine your business ("Happy Clothes Shop") is a separate person living in its own apartment. You (the owner) live somewhere else.
If the business pays rent for its shop, that’s a business expense. If the owner pays their personal phone bill, that is not the business’s expense—even if the owner uses money from the business bank account.

Key Term: When the owner takes cash or goods out of the business for personal use, we call these Drawings. Drawings reduce the owner’s investment in the business; they are not treated as business expenses.

Quick Takeaway for Entity Concept:

Business = Balance sheet (focus on the business’s finances)
Owner = Outside (keep personal finances out of the accounts)

2. The Money Measurement Concept (The Quantification Rule)

What does it mean?

The Money Measurement Concept states that only transactions or events that can be expressed in monetary terms (e.g., dollars, pounds, euros) are recorded in the accounting books.

• If you buy a delivery van for \$20,000, we record \$20,000.
• If you hire a genius manager, their genius skill is important, but we cannot measure it in money directly, so we don't record the skill itself—only their salary.

The Challenge of Non-Monetary Events

Accounting records ignore extremely important non-monetary events, such as:

• The high quality of staff morale (how happy the employees are).
• A major economic recession that hasn't affected sales yet.
• The death of a key manager.

These things are crucial for the business's success, but because they cannot be reliably assigned a monetary value, they are left out of the formal accounting records.

Quick Takeaway for Money Measurement:

If you can’t put a price tag on it, it doesn’t go into the accounts.

3. The Historical Cost Concept (The Original Price Rule)

This concept relates specifically to how we value assets.

What does it mean?

The Historical Cost Concept requires that assets (like buildings, machinery, or equipment) are recorded in the books at their original purchase price (the price paid when they were first acquired).

Why don't we use Market Value?

If you bought a piece of land ten years ago for \$100,000, it might be worth \$500,000 today. However, due to the Historical Cost Concept, it remains recorded in your accounts at \$100,000 (minus any depreciation).

We use historical cost because it is objective and reliable. We have an invoice proving the \$100,000 purchase price. Trying to estimate the market value (\$500,000) every year is subjective and less reliable.

Quick Takeaway for Historical Cost:

Record the actual price you paid. Use the invoice, not a guess!

4. The Dual Aspect Concept (The Balancing Rule / Duality)

This concept is the core mechanism that makes the whole accounting system work. It is why accounting is sometimes called "Double-Entry Bookkeeping."

What does it mean?

The Dual Aspect Concept states that every single business transaction has two effects (or two aspects) on the accounts. For every 'giving,' there must be a 'receiving.' This ensures the financial position of the business always remains balanced.

The Analogy: The Financial Seesaw

Imagine a financial seesaw. Whenever something happens, both sides of the seesaw must move equally to stay balanced.

We express this concept using the fundamental Accounting Equation:

$$ \text{Assets} = \text{Capital} + \text{Liabilities} $$

Every transaction will either:
1. Change two items on the same side (e.g., one Asset goes up, another Asset goes down by the same amount).
2. Change items on both sides equally (e.g., Asset goes up, Liability goes up by the same amount).

Step-by-Step Example

Let's say the business buys new inventory (goods to sell) for \$500 cash.

1. Effect 1 (The Receive): The business receives new Inventory (an Asset). Inventory increases by \$500.
2. Effect 2 (The Give): The business gives away Cash (also an Asset). Cash decreases by \$500.

The total value of Assets remains the same, but the mix changes (Cash -500, Inventory +500). The equation remains balanced!

Did you know? This principle is the entire basis for creating the Trial Balance at the end of an accounting period, which checks that all your entries are equal and balanced.

Quick Takeaway for Dual Aspect:

Two sides to every story! (In accounting, two sides to every transaction!)
If your accounts don't balance, the Duality Concept confirms you have made a mistake.

Final Review: The Four Pillars

Great job! By understanding these four concepts, you now know the basic rules of the accounting world. You are ready to move on to using the Double-Entry system!