Postulates in Accounting

The following points highlight the four important postulates in accounting. The postulates are: 1. Entity Postulates 2. Going Concern Postulate 3. Money Measurement Postulate 4. Time Period Postulate.

Postulate # 1. Entity Postulates:

The entity postulate assumes that the financial statements and other accounting information are for the specific business enterprise which is distinct from its owners. Attention in financial accounting is focused on the economic activities of individual business enterprises.

Consequently, the analysis of business transactions involving costs and revenue is expressed in terms of the changes in the firm’s financial conditions. Similarly, the assets and liabilities devoted to business activities are entity assets and liabilities.

The transactions of the enterprise are to be reported rather than the transaction of the enterprise’s owners. This concept therefore, enables the accountant to distinguish between personal and business transactions.

The concept applies to sole proprietorship, partnerships, companies, and small and large enterprises. It may also apply to a segment of a firm, such as division, or several firms, such as when interrelated firms are consolidated.

The assumption of a business entity somewhat apart and distinct from the actual persons conducting its operations, is a conception which has been greatly deplored by some writers and staunchly defended by others.

The distinction between the business entity and outside interests is a difficult one to make in practice in those business in which there is a close relationship between the business and the people who own it.

In the case of small firms where the owners exert day-to-day control over the affairs of the business and personal and business assets are intermingled, the definition of the business activity is more difficult for financial as well as managerial accounting purposes.

However, in the case of a company, the distinction is often quite easily made. A company has a separate legal entity, separate from persons who own it. One possible reason for making distinction between the business entity and the outside world is the fact that an important purpose of financial accounting is to provide the basis for reporting on stewardship.

Owners, creditors, banks and others entrust funds to management and management is expected to use these funds effectively. Financial accounting reports are one of the principal means to show how well this responsibility, or stewardship, has been discharged.

Also, one entity may be a part of a larger entity. For example, a set of accounts may be prepared for different major activities within a large organisation, and still another set of accounts may be prepared for the organisation as a whole.

Postulate # 2. Going Concern Postulate:

An accounting entity is viewed as continuing in operation in the absence of evidence to the contrary. Because of the relative permanence of enterprises, financial accounting is formulated assuming that the business will continue to operate for an indefinitely long period in the future.

Past experience indicates that continuation of operations is highly probable for most enterprises although continuation cannot be known with certainty. An enterprise is not viewed as a going concern, if liquidation appears imminent.

The going concern concept justifies the valuation of assets on a non-liquidation basis and it calls for the use of historical cost for many valuations. Also, the fixed assets and intangibles are amortized over their useful life rather than over a shorter period in expectation of early liquidation.

The significance of going concern concept can be indicated by contrasting it with a possible alternative, namely, that the business is about to be liquidated or sold. Under the later assumption, accounting would attempt to measure at all times what the business is currently worth to a buyer; but under the going concern concept, there is no need to do this, and it is in fact not done.

Instead, a business is viewed as a mechanism for creating value, and its success is measured by the difference between the value of its outputs (i.e., sales of goods and service) and the cost of resources used in creating those outputs.

The going concern concept leads to the proposition that individual financial statements are part of a continuous, interrelated series of statements. This further implies that data communicated are tentative and that current statements should disclose adjustments to past year statements revealed by more recent developments.

Postulate # 3. Money Measurement Postulate:

A unit of exchange and measurement is necessary to account for the transactions of business enterprises in a uniform manner. The common denominator chosen in accounting is the monetary unit. Money is the common denominator in terms of which the exchangeability of goods and services, including labour natural resources, and capital, are measured.

Money measurement concept holds that accounting is a measurement and communication process of the activities of the firm that are measurable in monetary teens. Obviously, financial statements should indicate the money used.

Money measurement concept implies two limitation of accounting.

First, accounting is limited to the production of information expressed in terms of a monetary unit; it does not record and communicate other relevant but non-monetary information.

Accounting does not record or communicate the state of chairman’s health, the attitude of the employees, or the relative advantage of competitive products or the fact that the sales manager is not on speaking terms with the production manager.

Accounting therefore does not give a complete account of the happenings in a business or an accurate picture of the condition of the business. Accounting information is perceived as essentially monetary and quantified, while non-accounting information is non-monetary and non-quantified.

Although accounting is a discipline concerned with measurement and communication of monetary of activities, it has been expanding into areas previously viewed as qualitative in nature. In fact, a number of empirical studies refer to the relevance of non-accounting information compared with accounting information.

Secondly, the monetary unit concept concerns the limitations of the monetary unit itself as a unit of measure. The primary characteristics of the monetary unit—purchasing power, or the quantity of goods or services that money can acquire—is of concern.

Traditionally, financial accounting has dealt with this problem by stating that this concept assumes either that the purchasing power of the monetary unit is stable over time or that the changes in prices are not significant. While still accepted for current financial reporting, the stable monetary unit concept is the object of continuous and persistent criticisms.

Postulate # 4. Time Period Postulate:

The financial accounting provides information about the economic activities of an enterprise for specified time periods that are shorter than the life of the enterprise. Normally, the time periods are of equal length to facilitate comparisons. The time period is identified in the financial statements.

The time periods are usually twelve months in length. Some companies also issue quarterly or half yearly statements to shareholders. They are considered to be interim, and essentially different from annual statements. For management use, statements covering shorter periods such as a month or week may be prepared.

Dividing business activities into specific time periods creates a number of measurement problems in financial accounting such as allocation of cost of an asset to specific periods, determining income and costs associated with long term contracts covering several accounting periods, treatment of research and development costs etc.

Accounting measurements must be resolved in the light of particular circumstances. There is no easy, general solution. The accountant and manager rely upon their experience, knowledge, and judgement to come to the appropriate answer.