Assumptions of Accounting for Working with QuickBooks 2012 - dummies

Assumptions of Accounting for Working with QuickBooks 2012

By Stephen L. Nelson

There are principles and assumptions that underlie business accounting and that you need to understand when working with QuickBooks 2012. It’s no exaggeration to say that they permeate almost everything related to business accounting.

Continuity assumption of accounting

The continuity assumption — accountants call it an assumption rather than a principle for reasons that are unclear — states that accounting systems assume that a business will continue to operate. The importance of the continuity assumption becomes most clear if you consider the ramifications of assuming that a business won’t continue.

If a business won’t continue, it becomes very unclear how one should value assets if the assets have no resale value. This sounds like gobbledygook, but think about the implicit continuity assumption built in to a balance sheet for a hot dog stand at the beginning of the day.

A Simple Balance Sheet
Cash $1,000
Inventory 3,000
Total assets $4,000
Accounts payable $2,000
Loan payable 1,000
Owner’s equity
S. Nelson, capital 1,000
Total liabilities and owner’s equity $4,000

Implicit in that balance sheet is the assumption that hot dogs and hot dog buns have some value because they can be sold. If a business won’t continue operations, no assurance exists that any of the inventory can be sold. If the inventory can’t be sold, what does that say about the owner’s equity value shown in the balance sheet?

You can see the sorts of accounting problems that you get into without the assumption that the business will continue to operate.

Unit-of-measure assumption of accounting

The unit-of-measure assumption assumes that a business’s domestic currency is the appropriate unit of measure for the business to use in its accounting. In other words, the unit-of-measure assumption states that it’s okay for U.S. businesses to use U.S. dollars in their accounting. And it’s okay for U.K. businesses to use pounds sterling as the unit of measure in their accounting system.

The unit-of-measure assumption also states, implicitly, that even though inflation and occasionally deflation change the purchasing power of the unit of measure used in the accounting system, that’s still okay. Sure, inflation and deflation foul up some of the numbers in a firm’s financial statements. But the unit-of-measure assumption says that’s usually okay — especially in light of the fact that no better alternatives exist.

Separate entity assumption of accounting

The separate entity assumption states that a business entity, like a sole proprietorship, is a separate entity, a separate thing from its business owner. And the separate entity assumption says that a partnership is a separate thing from the partners who own part of the business.

The separate entity assumption, therefore, enables one to prepare financial statements just for the sole proprietorship or just for the partnership. As a result, the separate entity assumption also relies on a business being separate and distinct and definable as compared to its business owners.