Financial Accounting: In an Economic Context

ASSUMPTIONS OF FINANCIAL ACCOUNTING

There are four basic assumptions of financial accounting: (1) economic entity, (2) fiscal period, (3) going concern, and (4) stable dollar. These assumptions are important because they form the building blocks on which financial accounting measurement is based. Some are reasonable representations of the real world, and others are not. As each assumption is discussed, try to understand why it has evolved, and be especially aware of those that fail to capture the world as it really is.

Economic Entity Assumption

The most fundamental assumption of financial accounting involves the object of the performance measure. Should the accounting system provide performance information about countries, states, cities, industries, individual companies, or segments of individual companies? While it is important that each of these entities operate efficiently, financial accounting has evolved in response to a demand for company-specific measures of performance and financial position. Consequently, financial accounting reports provide information about individual, profit-seeking companies.

The process of providing information about profit-seeking entities implicitly assumes that they can be identified and measured. Individual companies must be entities in and of themselves, separate and distinct from both their owners and all other entities. This statement represents the economic entity assumption, the first basic assumption of financial accounting. This assumption ...