Accounting principles, concepts, standards and policies
Concepts such as going concern, accrual and consistency guide every entry. Standards (SLFRS/LKAS) turn them into rules; policies are the methods a business chooses.
Key accounting concepts
| Concept | Meaning | Example |
|---|---|---|
| Business entity | The business is separate from its owner | Nimal's home electricity bill is not a shop expense |
| Money measurement | Only items measurable in money are recorded | Staff loyalty is not recorded |
| Going concern | Assume the business will continue in the foreseeable future | Equipment is shown at cost less depreciation, not at break-up value |
| Accrual (matching) | Record income when earned and expenses when incurred, not when cash moves | March electricity paid in April is a March expense |
| Consistency | Use the same methods from year to year | Keep straight-line depreciation each year unless a change is justified |
| Prudence | Be cautious: do not overstate assets or income, or understate liabilities | Inventory at the lower of cost and net realisable value |
| Historical cost | Record assets at what they cost | Land bought for Rs. 5,000,000 is recorded at that amount |
| Materiality | Small items need not be treated strictly | A Rs. 500 stapler is expensed, not depreciated |
| Dual aspect | Every transaction has two equal sides | Total debits = total credits |
| Accounting period | Report for fixed periods | Year ended 31 March 2026 |
| Realisation | Revenue is recognised when it is earned | A sale is recorded on delivery, not when the order is taken |
Qualitative characteristics of useful information
These come from the Conceptual Framework that underlies the standards. Cost is a constraint: the benefit of information should exceed the cost of producing it.
Accounting standards in Sri Lanka
Accounting standards are authoritative rules on how to recognise, measure, present and disclose items in financial statements. In Sri Lanka they are issued by CA Sri Lanka (The Institute of Chartered Accountants of Sri Lanka). SLFRS are based on IFRS and LKAS on IAS. Standards make statements comparable between companies and years, reduce manipulation and build trust among investors, lenders and the public. For example, the standard on inventories requires inventory at the lower of cost and net realisable value and does not allow LIFO.
Accounting methods and policies
Worked example: a policy choice changes profit (FIFO vs weighted average)
A shop bought 100 phone covers at Rs. 200 each and then 200 more at Rs. 230 each. It sold 250 covers. Find the cost of goods sold and closing inventory under FIFO and under weighted average.
- Total cost of goods available: 100 × 200 + 200 × 230 = 20,000 + 46,000 = 66,000.
- FIFO cost of goods sold: first 100 × 200 = 20,000, then 150 × 230 = 34,500; total 54,500.
- FIFO closing inventory: 50 × 230 = 11,500. Check: 54,500 + 11,500 = 66,000.
- Weighted average cost per unit: 66,000 ÷ 300 = 220.
- Weighted average cost of goods sold: 250 × 220 = 55,000; closing inventory: 50 × 220 = 11,000. Check: 55,000 + 11,000 = 66,000.
FIFO: cost of goods sold Rs. 54,500, closing inventory Rs. 11,500. Weighted average: Rs. 55,000 and Rs. 11,000. With rising prices, FIFO shows Rs. 500 more profit.
Worked example: prudence and the lower of cost and NRV
Closing inventory of school bags cost Rs. 120,000. They can be sold for Rs. 115,000, but selling costs of Rs. 10,000 will be needed. At what value is the inventory shown?
- Net realisable value (NRV) = selling price − costs to sell = 115,000 − 10,000 = 105,000.
- Compare cost 120,000 with NRV 105,000 and take the lower: 105,000.
- Write-down = 120,000 − 105,000 = 15,000, recognised as an expense this year.
Inventory is shown at Rs. 105,000 and a loss of Rs. 15,000 is recognised now.
Sri Lankan listed companies such as Hayleys PLC state their accounting policies in the notes to the annual report, for example how inventory is valued and how assets are depreciated, so that readers can compare years and companies.
Short answer: “What is the going concern concept?” The assumption that the business will continue operating in the foreseeable future, so its assets are not shown at break-up values.
Structured question: “Explain five accounting concepts with examples.” Define five (business entity, going concern, accrual, consistency, prudence) with one rupee example each.
Essay: “What are accounting standards? Explain the need for them and the qualitative characteristics of useful financial information.” Define standards, name CA Sri Lanka, SLFRS and LKAS, give four reasons for standards, then explain the two fundamental and four enhancing characteristics.
Fundamental qualities R-F: Relevance and Faithful representation. Enhancing qualities C-V-T-U: Comparability, Verifiability, Timeliness, Understandability.