Basic Principles of Accounting - Essay Example

The convention states that items recorded in financial statements should be recorded at the original cost for which it would be bought. Stating furniture at the present cost will be misleading and the account will not conform to legal standards. 3. Depreciation is an attempt to measure the worth of a fixed asset that was used in the period under review. It therefore divides the useful life of a given fixed asset into a number of years. Each year, there is an estimate of the worth of the asset that was used in the production process.

This way, accountants can get close to getting the true picture of how much was spent in a given year. Accumulated depreciation represents the worth of the asset deducted in the previous years that the asset was used in production. 4. The payment of $20,000 in June 2008 is cannot be put in the income statement of 2007/2008. This is because that insurance payment added no value to production in the 2007/08 year. However, that payment gives your company the right to future benefits. In other words, it is an asset and it must be accounted for in the Balance Sheet as an Accrual. 5. Gross profit represents sales less cost of sales or direct cots.

Net profit is gross profit less other production costs like overheads, indirect costs, as well as taxation. Net profit is important as it gives the whole view of trading activities in the company over a period of time. Gross profit just gives a shallow indication of events in the organization. 1. Direct cost is a cost directly attributable to a project or activity in a business. Indirect costs are activities that cannot be directly attributed to a single activity or process in the business. Manufacturing overheads is an indirect cost because it relates to the factory’s cost that cannot be identified with a single product or activity.

Examples include electricity and depreciation costs. 2. Work in progress refers to costs of unfinished raw materials that are