Four fundamental assumptions in preparing financial statements

Introduction

When we talk about financial statements, we normally refer to the four main types of the financial statements. Those are statement of financial position which we normally call Balance Sheet, Statement of comprehensive income or income statement, statement of changes in equity and finally statement of cash flow. Each statement serve for different purposes. The primary objective of providing the information of such statements is to see the financial position, performance and cash flows of an entity which is very useful for economic decision making.

Four Fundamental Assumptions in preparing Financial Statements that You Should Know

There are four main fundamental assumptions that you should know when preparing the financial statements to ensure that they are at high quality. Those are fair presentation, going concern, accruals and consistency

Fair presentation

Fair presentation is an assumption to ensure that the financial statements are prepared and presented fairly the financial position, performance and cash flows in accordance with all relevant International Accounting Standard (IASs)/International Financial Reporting Standard (IFRSs). This means that an entity need to disclose about the compliance with the IASs/IFRSs and all relevant IASs/IFRSs must be followed if the entity is in compliance with IASs/IFRSs.

In addition, an entity cannot rectify even though they provide any disclosure of accounting policies or explanatory notes if they has used an inappropriate accounting treatment.

Going Concern

Basically, going concern is one of the concept that assumes the business activities will continue for foreseeable future and there is no any intention to liquidate nor scale down its operations in a material way. In practice, we normally examine the going concern by looking at the revenue growth of an entity as well as the long term business planning. We can also examine by looking at the valuation of assets. To be in the going concern, an entity should not value it assets at the break-up value; the amount that would be sold off and the business is broken up. 

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Accruals

Accruals basis of accounting is one of the accounting concept that recognize revenues and expenses when they are earned or incurred regardless of cash receipt or payment is made. Similar to the matching principle, in calculating and recognizing the revenue earned, the expenses must be matched against that revenue recognition in that particular period.

Consistency

Consistency of presentation refers to the presentation and classification of items in the financial statements should be in the same way from one period to another. There are two exceptions where an entity can depart from this consistency principle. First, when there is a significant changes in the nature of operations or a review of financial statements indicate to be more appropriate presentation. Last but not least, when the changes in presentation is required by IFRS.

In addition, apart from the four fundamental assumptions mentioned above, IAS 1 also considers three other concepts which are extremely important in preparing the financial statements. Those are prudence, substance over form and materiality.

We consider an entity as prudence when assets or income are not materially overstated and liabilities and expenses are not materially understated.

Substance over form is where transactions and other events are recorded for and presented in accordance with their substance of economic reality not based on their legal form.

Finally, in preparing the financial statements, an entity should also take into account the materiality. Information is considered as material when its omission or misstatement could influence the economic decision. Therefore, in preparing the financial statements, any material items should be disclosed separately while the immaterial items can be presented in aggregation with amount of similar nature or function.

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