ZIMSEC O Level Principles of Accounts Notes: The Accruals concept and the Materiality concept

  • As we has already been pointed out in another topic here
  • The accounting function is governed by several concepts which form part of what are known as International Financial Reporting Standards
  • In this topic we will look at:
    1. The Accruals/Matching Concept and
    2. The Materiality Concept

The Matching or Accruals Concept

  • In accounting the matching concept applies in several ways
  • The concept states that:

Revenue must be matched against Expenditure incurred in generating that revenue

  • What this means is that expenses must be recorded in the period in which they occur regardless of whether payment is made or not
  • Amounts owing are therefore recorded in the books as accruals
  • At the end of the trading period these expenses are included in the Income Statement even if they had not been settled yet
  • Similarly revenue amounts for the period are recorded as accrued income even if the business might not have yet received payment
  • Also prepaid expenses revenue are not included in the Income Statement as they relate to future periods
  • According to the Accruals Concept:

Revenues-Expenses=Net Profit

  • Determining the expenses used up to obtain the revenues is referred to as matching expenses against revenues
  • According to the matching concept these expenses and revenues must be confined to those that relate to the period under consideration no more no less

Materiality

  • These concept states that all material financial transactions that take place must be recorded and included in both the accounts and financial statements
  • A item is considered material if it is of importance to at least one of the business’s stakeholders
  • To learn more about stakeholders of the business click here
  • An item is also considered material if its inclusion or exclusion would impact on the perceptions/decisions of the stakeholders
  • For example the cost of purchasing a pen, paper clips might be recorded separately
  • We could also create a stapler account and calculate depreciation for it in the books
  • None of these things are done since the cost of these items is immaterial instead they are most likely treated as Stationery expenses
  • It is important to note that materiality varies from business to business
  • What might be material to a sole trader would not be material to for example an institution like J P Morgan one of the largest banks in the world
  • Materiality dictates that time be not wasted on immaterial items
  • It also ensures that all important items are recorded in the books

To access more topics go to the Principles of Accounts Notes.

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