Accounting is based on principles such as:

The accrual principle – the transaction or event must be recorded in the financial period in which it occurs irrespective of when the cash is received or paid.

The principle of consistency – the same accounting policies are used to compare different financial periods. If a policy was changed, it must be disclosed in the financial statement as well as the effect thereof.

The prudence principle – when the value of an asset, liability, income or expense cannot be determined with certainty, then the value which has the most unfavourable effect on the equity of the business, must be used (i.e. a conservative approach to uncertainties).

The principle of materiality – all material transactions and events should be disclosed separately in the financial statements.

The matching principle – income and the expenses incurred in generating the income must be brought into account (matched) during the same financial period.

The realisation principle – income and expenses are brought into account as soon as it has been earned or expensed. For income to be realised, the collectability of the income must be reasonably certain and measurable.

Transactions of a repetitive nature frequently occur, and the principle of consistency requires a business to establish an accounting policy which determines how these transactions will be treated.

A business must disclose its accounting policies in its financial statements i.e. a business must indicate what basis it has used to treat the same type of transactions in order to achieve a consistent result.

The principle of double entry means that every transaction entered into will affect at least two accounts. One account will be debited, and the other account credited.

The following rules for debiting and crediting apply:

• If an asset increases (+), the relevant asset account is debited (credited if assets decreases).

• If a liability increases (+), the relevant liability account is credited (debited if liability decreases).

• If capital increases (+), the capital account is credited (debited if capital decreases).

• If income increases (+), the income account is credited (debited if income decreases).

• If expenses increase (+), the expense account is debited (credited if expenses decrease).

The Statement of Financial Position (balance sheet) is an accounting report on the financial position of a business. It communicates relevant information to the owners, creditors and other interested parties.

The balance sheet depicts the assets, equity and liabilities of the business.

Assets are what the business owns.

Equity is the personal money or assets which the owner has invested in the business.

Liabilities are the debt of the business. These are the creditors’ interest or interests of parties other than the owner (e.g. bank and suppliers).

The Statement of Comprehensive Income (income statement) is an accounting report on the financial result or performance of a business.

The financial result or performance is measured in terms of the profit or loss which the business has made over a specific period, which is normally a year.

Financial result = Income – Expenditure = Net Profit (income more than expenses) or Net Loss (expenses greater than income).