1.2 Accounting Assumptions

Accounting assumption is a reasonable setting for the scope, contents, basic procedures, and methods of accounting. It's also the basic premise of accounting calculation which could guarantee the quality of normal accounting work and accounting information. There are four major accounting assumptions, the business entity, the going-concern, the monetary unit, and the time period.

1.2.1 Business Entity

The business entity assumption means a business entity should be accounted separately from other business entities, including its owner. The business entity here is a unit which has independence or relative independence in management or economy. It's also an economic unit stands on its own interest.

For example, David owns a shoe shop, a farm, and other personal assets.When we try to measure the performance of the shoe shop in making profit, the shoe shop should be measured as an independent economic entity and accounted separately from the farm and David's other personal assets.

As the basic premise of accounting, it's of great significance to identify the business entity. Firstly, business entity assumption helps to define the spacial scale of accounting. It requires that the accounting records and financial statements involve only the economic activities of the enterprise itself, but not the economic activities of its owner or creditor, or that of other enterprises or business entities.Secondly, this assumption defines the scope of economic business activities and events that need to be treated by the accounting. Only those activities or events that influence the economic interest of the business entity should be reflected and recorded. And only by this way, could the financial position, operating results, and cash flows of the enterprise be correctly reflected, and could the useful accounting information be obtained by the owners, creditors, and other stakeholders of the enterprise.

It should be pointed out that business entity is different from legal entity. The latter refers to the legal subject that has registered in relevant government offices,owns independent properties and could undertake civil responsibilities. Generally speaking, a legal entity must be a business entity, but a business entity is not always a legal entity. A business entity could be a legal entity and it also could be a non-legal entity. It can be the whole enterprise; can also be an internal unit of the enterprise, such as a branch. It can be a single company; can also be a group company or an affiliated enterprise which is organized by the holding relationship.

1.2.2 Going-concern

The going-concern assumption means the business activities of an accounting entity will continue indefinitely, and will not disappear for bankruptcy, liquidation,and dissolution in the foreseeable future. Meanwhile, if a specific entity is actually threatened by bankruptcy or liquidation, the going-concern assumption should be abandoned. Under this situation, what we are interested in is the liquidation value,but not the value assuming that the business will continue. If the going-concern assumption is not applicable because of threatens from liquidation or bankruptcy,the financial statements must clearly disclose this situation.

Only on the premise of normal operation of an enterprise, the acquisition of fixed assets can be priced on the historical cost, the debt can be repaid according to the original provisions, the accounting treatment methods can be remain unchanged, and the information contained in the accounting records and financial statements can be true and reliable. For example, a company purchases a production line, which is expected to last 10 years. Under the going-concern assumption, since the enterprise will stay in business indefinitely, we could assume that this production line will keep bringing benefits to the enterprise and serving its production until the life of this line is over. Therefore, the original value of this production line can be determined by historical cost and then be depreciated with certain depreciation method to allocate the historical cost to related products that are produced by this production line. Moreover, the going-concern assumption also influences the identification and classification of assets and liabilities. The audit opinion could show the attitude of an auditor to the going-concern status of an enterprise.

1.2.3 Monetary Unit

The monetary unit assumption means that the accounting is based on the measurement of currency with currency stability. Because only in the situation of currency is stable or relatively stable, the asset value at different points of time can be comparable, the income and expense during the same period can be compared, operating results can be calculated and determined, and the accounting information provided by the financial statements can truly reflect the operating condition of an enterprise.

Money is the common ground of business. For example, countries with the monetary unit of dollar are the Unites States and Canada, and those of peso are Mexico, Philippines, Chile, etc. Which money to be chosen as the monetary unit of an enterprise depends on the country in which it operates. However, many companies are preparing financial reports with more than one monetary unit. The monetary unit assumption requires that an enterprise only record those transactions that could be reflected by money. This assumption also enables the economic events to be accountable.

In various countries, the stability of monetary unit has always been a big problem. The loss in value of money is called inflation. In some countries, the inflation rate of each year has been more than 300%. In those countries where inflation has been so significant, the financial statements need to be adjusted by an inflation factor so as to realize the significance of money as a unit of measurement.

This assumption fails to include some of the relevant information in the accounting records, such as the health of a company's owner, the quality of service, the morale of employee and etc. The reason is that although this kind of information is very important, enterprises cannot quantify them into monetary terms. The accounting just records transactions and events that can be measured in money.

知识拓展1-1 美国会计对通货膨胀确认的发展历程

在20世纪70年代之前，美国公布的通货膨胀率相对较低。因此，有人认为，以调整的货币价值进行计量是不恰当的，因为增加的费用和扣除通货膨胀因素的误差均大于收益。然而，在20世纪70年代，美国经历了两位数的通货膨胀率，这使得人们越来越需要对通货膨胀做一些正式的确认。

1979年9月，财务会计准则委员会（FASB）发布了财务会计准则公告（Statement of Financial Accounting Standards）第33号，“财务报告和物价变动”，要求某些大型上市公司披露有关价格变动对其当年财务报告影响的补充信息。1986年，这一要求变成了可披露也可不披露。目前，美国企业不需要提供这一补充信息。

1.2.4 Time Period

The time period assumption presumes that the life of a going-concern company can be divided into periods, such as months, quarters, years, so that financial reports can be prepared separately by those periods.

According to the going-concern assumption, a business will continue to operate by the current size and status. In order to ultimately determine the enterprise's production and operating results, it seems to have no other choice but to wait until the enterprise is out of business. However, the typical business has a relatively long duration, and what the managers, investors, creditors, and other decision makers need is timely information. So it is not feasible to wait until the business liquidated before accounting for its success or failure. It's necessary for enterprises to divide its whole life into continuous period of equal duration, and then to recognize, measure, and report its financial condition, operating results, and cash flows in each period. Just because of the time period assumption, there are differences between current period and the period before or after, the differences between accrual basis accounting and cash basis accounting. The time period assumption also makes different types of accounting entities have an accounting benchmark, and then exerts receivables, payables, depreciation, amortization, and other accounting treatment methods.

In order to facilitate a better measurement of income and financial position,some businesses select a natural business year as accounting year which ends when operation is at low ebb. Some businesses use the calendar year which end on December 31 as their accounting year. However, because the natural business year of some businesses, such as insurances, is also ends on December 31, sometimes it's hard to determine whether this December 31 represents a natural business year or a calendar year. Moreover, some businesses select a fiscal year as their accounting year, which includes 12 consecutive months and closes at the end of a month other than December. In addition, the accounting period could also be shorter than a year, such as a month, a quarter, and etc. Usually, the shorter the period of the time, the more accuracy is expected in financial reporting.

In summary, these four fundamental accounting assumptions depend on each other and complement each other. The accounting entity assumption establishes the scope of accounting. The time range of accounting is established by the going-concern assumption and time period assumption. Monetary unit assumption provides the necessary means for accounting. Without the accounting entity assumption, the going-concern assumption would lose its meaning. There would be no time period without going-concern assumption. Without monetary unit assumption, there would be no modern accounting.