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Applying accounting concepts at the year end
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At the end of the year, accountants make adjustments so the financial statements follow the accounting concepts.
Accruals and prudence
Accruals: adjust expenses and income for amounts owing and prepaid, so each year shows only its own income and expenses. Depreciation also applies accruals.
Prudence: make a provision for irrecoverable debts; value inventory at the lower of cost and net realisable value (what it can be sold for, less selling costs).
Prudence: make a provision for irrecoverable debts; value inventory at the lower of cost and net realisable value (what it can be sold for, less selling costs).
Consistency and materiality
Consistency: use the same depreciation method and inventory valuation each year, so years can be compared.
Materiality: small items (such as a cheap tool) can be treated as expenses, and small adjustments may be ignored if they would not affect decisions.
Materiality: small items (such as a cheap tool) can be treated as expenses, and small adjustments may be ignored if they would not affect decisions.
Business entity and money measurement
Business entity: goods taken by the owner for personal use are recorded as drawings, not as a business expense.
Money measurement: only items with a money value are included, so the skill of staff is not shown as an asset.
Money measurement: only items with a money value are included, so the skill of staff is not shown as an asset.
Inventory cost £5000 but is damaged and can now only be sold for £3200. At what value should it appear, and why?
- Prudence: lower of cost and net realisable value.
- 3200 is lower than 5000.
Answer: £3200, because of prudence
Year-end adjustments apply the concepts: accruals (owing and prepaid items, depreciation), prudence (provisions, lower of cost and net realisable value), consistency, materiality, business entity (owner's goods as drawings) and money measurement.
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