Accruals Concept in Finance and Accounting

Accruals concept is the concept that attempt to correctly match all the accounting expenses (cost) to the income (revenues) to the year at which it occurs at that accounting period, thus referred to as accrued expenses. Whilst a going concern is an assumption that every business will continue in operation for the anticipated future, thus is a going concern for several years, unless if there is evidence i.e. owner acknowledgement. In the Introduction to Accounting Book by Marriott, Edwards& Mellett 3rd Edition it states, “The going concern concept assumes that the business is a permanent venture and will not wound up in the foreseeable future”
However, problems might arise in companies applying the two concepts, accruals and the going concern. Firstly looking at the accruals concept, “Under the accruals concept, revenue and costs are credited or charged to the profit and loss account for the year in which they are earned or incurred, not when any cash is received or paid” (http://www.tutor2u.net/newsmanager/templates/?a=1373&z=82 ) . Therefore this manipulates the accounting statement in way that income shown is not what the business received and then the concept attempts to spread the cost. Thus the concept provides a false picture as to what cash reserves are available within the business, which could result in serious cash flow problems. For instance, the income ledger may show thousands of dollars in sales, while in reality the bank account is empty because debtors haven’t paid you yet, therefore the problems will arise when the debtors finds it hard to pay off the credit, or they might delay with their payment due to unforeseen factors this will then affect the company’s working capital, which is the amount the business have for day to day expenses. Thus, the profit indicated in the profit and loss account or the balance sheet is unrealistic, in short terms this reflects a false picture on the actual business performance at the end of the accounting period i.e. yearly.

The main purpose of recording the business transactions, so called financial accounting is defined clearly in the Introduction to Accounting Book by Andrew Thomas 5th Edition: “Financial Accounting is the process of designing and operating an information system for collecting, measuring and recording an enterprise’s transactions and summarizing and communicating the results of the transactions to the users.” The part I want to draw attention on the definition is ‘communicating to the users,’ thus if there is a false reflection of the business cash or profit for the business at that short-term period, external users of the financial information i.e. potential investors’ evaluation on the business performance whether to invest or not will be adversely affected. This is because business might not be able to payback the invested money due to its liquidation problems. Therefore in a way, if the accruals concept results in this, there is an element of deceitfulness in the accounts to show the exact performance of the firm at that point of time.
The concept also brings about the technique of “depreciation of fixed assets in the balance sheet and profit and loss account. The concept requires the firm to estimate the net cost of the asset (i.e. cost less residual value) and charge it to the periods expected to benefit from its use (i.e. its useful economic life). In other words, this technique will be matching the cost of using the asset with the revenue it helps to generate.” (http://www.accaglobal.com/students/publications/finance_matters/archive/2000/43/15563). The problem with this is when different methods of depreciation are used within the firm or for firms within the same industry. Therefore the firm can not compare to its competitors accurately as different method have been applied in their accounting statement, and also comparing the performance of the firm from its past year(s) might be inaccurate.
The problem for companies applying the going concern is that it affects the business activity, in terms of how the entity functions basing on its objectives. The concept assumes that the firm is going to remain in existence for and beyond the foreseeable future; therefore the main objective will be on continuity. Therefore techniques like depreciation are used when preparing the books of accounts, fixed assets will normally be shown in the balance sheet at cost less accumulated depreciation. The use of this concept also includes a large amount of judgement on the future basing on the information accessible at that point of time when the judgement is made. Therefore historistic information is used, however they are other external factors that affect the entity in future that are not taken in account, i.e. the inflation might affect the prices with in the market, therefore the residual value that is used for depreciation for the fixed assets, might not be what has been predicted, therefore the firm is likely to either over-value or under value its assets…




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