The principles, concepts, assumptions and conventions of accounting, and where they come from

What this chapter is for

Every set of accounts in the world, from a shop’s notebook in Raja Bazaar to the annual report of a bank, is built on a small number of agreed rules. This chapter teaches those rules. It shows what each one says, why it exists, and how to use it to decide what goes into the accounts and at what amount. It also teaches the four words that FPSC uses for them, principles, concepts, assumptions and conventions, and why different books sort the same rules under different words.

By the end you will be able to name and explain each rule, apply it to a list of business events and correct a profit figure with it, and show where each old rule now lives in the International Accounting Standards Board’s Conceptual Framework of 2018 and in Pakistan’s Companies Act 2017. The chapter is long, so here is its map. Sections 1 to 6 explain why rules are needed, what the four words mean, the rules themselves and where they came from. Sections 7 and 8 show the modern home of the rules, the Conceptual Framework. Sections 9 to 12 teach you to apply them, first by watching, then with help and then alone. Sections 13 and 14 cover Pakistani law and the common mix-ups, and the last four sections prepare you for the exam.

This is the first head of Paper-I, and the paper has set it directly once since 2016. The CE-2023 paper gave ten marks to defining four principles and four conventions.² The rules matter far beyond that one question, because every computation in Paper-I applies them, and several Part-I questions test them by name.³

Before you start

The words

• Business. In accounting, any organisation whose accounts are kept: a shop, a factory, a company, a club. The accounts are always the accounts of one business, kept apart from its owner.
• Transaction. An event that changes what the business owns or owes and can be measured in money: a sale, a purchase, a payment of wages.
• Asset. Something the business controls that will bring it benefit, such as cash, stock of goods, a machine or money that customers owe it.
• Liability. An amount the business owes to someone outside it, such as an unpaid bill or a bank loan.
• Capital (in a company, equity). What is left for the owner when the liabilities are taken away from the assets.
• Revenue (or income). What the business earns by selling goods or services.
• Expense. A cost used up in earning revenue, such as rent, wages or electricity.
• Profit. Revenue less expenses for a period. A loss is the same sum when the answer is negative.
• Financial statements. The finished accounts: the income statement (profit and loss account), the balance sheet (statement of financial position) and, for larger businesses, the statement of cash flows and the notes.
• Accounting standard. A written rule on one area of accounting, such as how to account for inventory. The international ones are called IAS (International Accounting Standards, the older series) and IFRS (International Financial Reporting Standards, the newer series).

The bodies

• The IASB, the International Accounting Standards Board in London, writes the international standards and the Conceptual Framework. It works under the IFRS Foundation.
• The SECP, the Securities and Exchange Commission of Pakistan, is Pakistan’s regulator of companies. It decides which international standards become law in Pakistan.
• ICAP, the Institute of Chartered Accountants of Pakistan, is the body of the country’s chartered accountants. Its Accounting Standards Board studies each new standard and recommends it to the SECP.

The story in plain words

1. Two people can keep honest accounts of the same shop and still report different profits, because each made different choices.
2. Accountants over five centuries agreed on rules so that everyone makes the same choices in the same way.
3. Some rules are things we assume (the business is separate from its owner; it will carry on trading), some are rules of recording (record at cost; record a sale when it is made) and some guide judgement (be careful; do not change methods without reason).
4. Textbooks call these rules principles, concepts, assumptions and conventions, and they do not all sort them the same way.
5. Since 1989 the international standard-setter has kept the rules in one document, now the Conceptual Framework of 2018.
6. In Pakistan the Companies Act 2017 makes companies follow the standards that rest on these rules.

1. Why two honest people can report two different profits

Shahid runs a small mobile phone shop in Saddar, Rawalpindi. At the end of June 2026 he asked his cousin Bilal, who is good with figures, to work out the shop’s profit for the year. Bilal went through the bank statement, the cash book and a carton of bills, and announced a profit of Rs 912,000. Shahid then showed the same papers to a chartered accountant, who reported a profit of Rs 812,920. Neither of them had made an arithmetic mistake, and neither was trying to cheat. They had simply made different choices about what to count.

Look at three of those choices. Shahid had paid his home electricity bill of Rs 18,000 from the shop’s till, and Bilal counted it as a shop expense. Shahid felt that the shop had become more valuable because the market around it was busier, and he guessed the rise at Rs 250,000; Bilal added that guess to the profit. In June the shop had sold phones on credit for Rs 140,000 to a school whose cheque came in July, and Bilal left those sales out because no money had arrived by 30 June. Each choice can be argued for. The electricity was paid from the shop’s money. The shop may well be worth more. The cash for the school’s phones had not come in.

The trouble is what happens to the reader of the accounts. Suppose Shahid wants a loan from a bank, or wants to bring in a partner. The banker reads a profit figure and makes a decision with it. If each shopkeeper chose for himself what to count, the banker would have no way of knowing what any profit figure meant. Two shops with the same profit might be very different businesses, and one shop’s profit might jump or fall from one year to the next simply because its owner changed his mind about what to include.

So accounting has rules that tell everyone how to make these choices. The home electricity is the owner’s own expense, not the shop’s, because the shop is treated as separate from its owner. The guess at the shop’s rising value is left out, because assets are recorded at what they cost, not at what the owner hopes they are worth. The school’s phones are a sale of June, because a sale is recorded when it is made, not when the cash arrives. Section 10 works through all ten of the differences between Bilal and the accountant, and each one is settled by a rule you will meet in this chapter.

The rules are not laws of nature. They are agreements, worked out over centuries by merchants, accountants, courts and lawmakers, about how to make accounts useful and comparable. Most of them are now written into the standards that a Pakistani company must follow by law. The rest of this chapter is about what those agreements say and why.

2. Four words for a rule, and why the books disagree

FPSC’s syllabus names this head “Fundamental Accounting Principles, Concepts, Assumptions and Conventions”.¹ These four words are not four separate lists of rules. They are four ways of describing the rules according to their nature, and the textbooks on FPSC’s reading list do not use them the same way. Before you learn the rules, learn what the words mean in plain English, because a question that says “What are the accounting conventions?” expects you to know.

An assumption is something taken as true without proof so that the accounts can be prepared at all. When you prepare accounts for a shop, you assume that it will still be trading next year, because otherwise you could not value its shelves and counters at cost. You assume that the shop is separate from its owner, because otherwise there would be no shop’s accounts to prepare, only a muddle of the owner’s life. Nobody proves these things. They are the ground the accounts stand on, and if one of them turns out false, the accounts must be prepared on a different basis.

A principle is a rule of recording. It tells you what to record, at what amount and when. “Record an asset at what it cost” is a principle. “Record a sale when it is made, whether or not the cash has arrived” is a principle. Principles are what a bookkeeper applies to each transaction, many times a day.

A convention is a custom that accountants have followed so long that it has become a rule, used where the principles leave room for judgement. “Do not change your methods from year to year without good reason” is a convention, and so is “when in doubt, do not overstate your profit”. Conventions grew up in practice rather than being reasoned out from first ideas, and older books describe them as rules followed because accountants generally agree on them.

A concept is the widest of the four words. It means simply an idea about how accounts should be prepared, and many books use it for all the rules at once, so that “the accounting concepts” means the whole list. Others use it for the basic ideas, and keep “principles” for the rules that follow from them.

Here is why you will find the same rule under different words. Going concern is called an assumption in American books such as Kieso and Weygandt and in the Conceptual Framework itself, but older British books call it a fundamental concept. Prudence was called a convention (“the convention of conservatism”) in older books, one of four fundamental concepts in Britain’s old standard on accounting policies, and is now a part of faithful representation in the Framework. Materiality is a convention in some books and a constraint in others. None of these sortings is wrong. They describe the same rules from different angles. In the exam, use the word the question uses, define it, and then give rules that fit your definition. A candidate who explains what a convention is before listing four conventions shows the examiner that the list is understood and not memorised.

The building in Figure 1 shows the sorting this chapter uses, which is the most common one in the books on FPSC’s list. The assumptions are at the bottom, because everything else rests on them. The principles stand on the assumptions and do the work of recording. The conventions sit on top and guide the judgements that the principles leave open. The next three sections take them in that order, with assumptions in section 3, principles in section 4 and conventions in section 5.

3. The assumptions underneath the accounts

There are four assumptions, and each answers a question that must be settled before a single entry is made. Whose accounts are these? What do we measure in? Will the business carry on? Over what stretch of time do we measure?

Whose accounts, and in what: the entity and money measurement

The business entity assumption says that a business is treated as a unit separate from its owner, and its accounts record only the business’s own transactions. This is true even for a sole trader like Shahid, although in law Shahid and his shop are the same person and he is personally liable for its debts. The accounts draw a line around the shop and record only what crosses that line. When Shahid takes money out of the till for himself, the shop records it as drawings, a reduction in his capital, not as an expense. When he puts his own car into the business, the shop records a new asset and an equal rise in his capital, and the car now belongs, for accounting purposes, to the shop.

The entity assumption is what makes capital a liability of the business in the old books’ sense, since the business owes the owner what they have put in. It is also why the accounting equation balances, as section 4 explains. For a company the line is drawn by law as well, because a company is a separate legal person. For a partnership, a club or a trust it is drawn by the accounts alone. The Conceptual Framework now calls the unit a “reporting entity”, an entity “that is required, or chooses, to prepare financial statements”, and notes that it “is not necessarily a legal entity”.⁶

The second assumption settles what the accounts measure in. The money measurement assumption says that the accounts record only what can be measured in money, and record it in one currency. A factory’s machines, stock and debts can all be stated in rupees and added together. Its skilled workers, its good name, its manager’s illness and a strike next month cannot be stated in rupees with any reliability, so they do not appear in the accounts, however much they matter to the business.

This is a real limit, and you should be able to say so in an answer. The accounts of Shahid’s shop show his stock of phones to the rupee, but they say nothing about the fact that he is the only shop in the street that repairs a certain brand, which may be why customers come. Money measurement also assumes that a rupee is a rupee from year to year. In a country where prices have risen as fast as they have in Pakistan in recent years, a machine bought for Rs 1 million in 2016 and one bought for Rs 1 million in 2026 are not the same amount of machine, yet the accounts add them together as if they were. The Framework states the rule simply: “Elements recognised in financial statements are quantified in monetary terms.”⁶

For how long: going concern and the accounting period

The going concern assumption says that the business will continue trading for the foreseeable future, and has neither the intention nor the need to close down. In the Framework’s words, financial statements “are normally prepared on the assumption that the reporting entity is a going concern and will continue in operation for the foreseeable future”.⁶ IAS 1 makes it a duty. Management must assess whether the entity can continue, and must prepare the accounts on a going concern basis unless it means to close the business or has no realistic choice but to do so.⁷

This assumption is what lets an accountant record a display counter at its cost and spread that cost over the eight years the shop will use it. If the shop were closing next month, the counter would be worth only what a buyer would pay for a second-hand counter, and the accounts would have to be prepared on a break-up basis, with every asset at what it would fetch in a sale. The Framework says exactly this. If the entity intends or needs to close, “the financial statements may have to be prepared on a different basis”, and they must say what basis was used.⁶ Going concern has its own chapter later in this head, where you will see what the signs of trouble are and what changes when the assumption fails.

Going concern says the business will carry on; the next assumption says how its long life is measured in pieces. The accounting period assumption says that the life of a business, which may run for a hundred years, can be divided into equal periods, usually a year, and a profit measured for each. Without this, a business’s true profit could only be known when it closed and every asset had been sold and every debt paid. Owners, lenders and the tax authorities cannot wait that long, so the accounts cut the business’s life into years and report on each one.

The cut causes most of the hard work in accounting. A year-end falls in the middle of things, such as rent paid for three months ahead, wages earned but not yet paid and goods sold whose cash has not come in. Deciding which year each of these belongs to is the work of the accrual and matching principles in the next section. In Pakistan most companies end their year on 30 June, which is also the end of the government’s financial year and of the normal tax year under the Income Tax Ordinance, and banks end theirs on 31 December. The Framework calls it the “reporting period”, and says financial statements “are prepared for a specified period of time”.⁶

4. The principles that decide what is recorded, at what amount and when

The assumptions settle the ground. The principles do the recording. There are five that every book on FPSC’s list teaches, and a sixth, objectivity, that the older books add.

At what amount, and when it is earned: cost and realisation

The historical cost principle says that an asset is recorded at what was paid for it, including the costs of getting it ready for use, and is not later raised to its market value. When Shahid’s shop buys a display counter for Rs 96,000, the counter goes into the books at Rs 96,000. If a dealer later offers Rs 120,000 for it, the books do not change. If the shop’s premises are worth more because the bazaar has become busier, the books do not change either, which is why Bilal’s Rs 250,000 guess was wrong.

The reason is reliability. Cost is a fact, shown on an invoice that anyone can check. Market value is an opinion, and opinions differ with the person giving them and the day they are asked. A rule that let owners write up their assets to their own estimates would let them make their profits whatever they liked. The weakness of the rule is just as real. After some years the cost of an old asset may say little about what it is worth, especially land in a city where prices have risen fast.

For that reason the modern rules allow more than one measure. The Framework names historical cost as one “measurement basis” and current value (fair value and others) as another, and says that historical cost “does not reflect changes in values, except to the extent that those changes relate to impairment”.⁶ Under IAS 16 a company may choose to carry its land and buildings at a revalued amount instead of cost, so long as it revalues regularly and does it for a whole class of assets, never for a single favourite one. The chapters on non-current assets teach revaluation. For this chapter, remember that historical cost is the starting point and the usual rule, and that a value an owner merely hopes for is never recorded.

Cost settles the amount of what the business buys. The next principle settles when the business has earned something by selling. The realisation principle (also called the revenue recognition principle) says that revenue is recorded when it is earned, which for goods is normally when they are handed over to the customer and the customer takes on the obligation to pay. It is not recorded when an order is taken, and it is not delayed until the cash arrives. The school’s phones were delivered in June, so they are June’s sales, though the cheque came in July. If a customer pays in June for phones to be delivered in July, the money is not yet revenue. It is an amount the shop owes the customer, in goods or a refund, and it is recorded as a liability until the phones are handed over.

Realisation also explains why a rise in an asset’s value is not profit. The shop has not sold its premises, so any gain is not realised. In the old books this was put as “anticipate no profit, but provide for all possible losses”, which joins realisation to the convention of prudence in section 5. Today the full rule for revenue is IFRS 15, Revenue from Contracts with Customers, which records revenue when control of the goods or services passes to the customer, and has a chapter of its own later in this subject.

Which year, both sides, and proof: matching, dual aspect and objectivity

The accrual principle says that the effects of transactions are recorded in the period in which they happen, not the period in which the cash moves. The matching principle, which follows from it, says that the expenses of a period are the costs used up in earning that period’s revenue, so they are set against that revenue in the same income statement. The two are often taught as one idea, because together they are what makes a profit figure mean something.

Take the shop again. In June it paid rent of Rs 45,000 for July, August and September. The cash left in June, but the rent is the cost of trading in the next three months, so it belongs to next year and is recorded now as a prepayment, an asset. In June the staff earned salaries of Rs 35,000 that were paid on 3 July. The cash left in July, but the work was done in June and helped earn June’s sales, so the salaries are this year’s expense and are recorded as an amount owing, a liability. The display counter will help earn revenue for eight years, so its cost is spread over those eight years as depreciation, and each year’s income statement carries one share.

The Framework puts the idea in its first chapter: accrual accounting “depicts the effects of transactions and other events and circumstances on a reporting entity’s economic resources and claims in the periods in which those effects occur, even if the resulting cash receipts and payments occur in a different period”.⁶ IAS 1 makes it a rule for everything except the cash flow statement.⁷ The Part-I paper of CE-2026 asked which principle “matches expenses with associated revenues”, and the answer was matching.⁴ A later chapter in this head is given wholly to the accrual basis and matching, with a shop’s month worked on both bases.

Matching decides which year an entry belongs to. Every entry also has two sides, and the next principle says why. The dual aspect principle says that every transaction has two equal effects on the business. When the shop buys phones for cash, its stock rises and its cash falls by the same amount. When it buys on credit, its stock rises and so does what it owes the supplier. When Shahid puts Rs 500,000 of his savings into the shop, its cash rises and so does his capital. Because both effects are always recorded, the business’s assets always equal the claims on them:

Assets = Liabilities + Capital

This is the accounting equation, and the system of recording both effects of each transaction is double entry, which you will learn in the next head of the syllabus. The Framework defines equity as “the residual interest in the assets of the entity after deducting all its liabilities”, which is the same equation turned round: capital is what is left when the liabilities are taken from the assets.⁶ A Part-I question of CE-2026 asked what happens when Mahnoor brings her car into her business. Assets and capital both rise, and the equation still balances.⁴

The last principle asks whether each entry can be checked. The objectivity principle, which older books list, says that entries should rest on evidence that a different person could check and agree with, such as an invoice, a receipt or a contract, rather than on someone’s personal view. Historical cost is objective because the invoice shows it. Shahid’s guess at his shop’s value is not, because another person would guess differently. The Framework keeps the idea under the name verifiability: different “knowledgeable and independent observers could reach consensus, although not necessarily complete agreement” that the figure is a faithful one.⁶ Notice that the modern word does not demand a single exact figure. An estimate, such as the useful life of a counter, can be verifiable if knowledgeable people would agree that it is reasonable.

5. The conventions that guide judgement

The principles leave room for judgement. How many years will the counter last? Will a doubtful customer pay? Should a Rs 1,200 calculator be recorded as an asset and depreciated? Four conventions guide those judgements, and each grew up because accountants learned in practice what happens without it.

Keeping to methods and taking care: consistency and prudence

The consistency convention says that a business, once it has chosen a method, keeps to it from year to year, and changes only for a good reason, saying so when it does. If Shahid’s shop values its stock on one method this year and another next year, part of the change in profit comes from the change of method and not from trading, and nobody reading the two years’ accounts can tell how much. Consistency makes the accounts of one business comparable over time. IAS 8 states the rule: an entity “shall select and apply its accounting policies consistently for similar transactions”, and IAS 1 says the way items are presented and classified must be kept from one period to the next.⁸⁷

Consistency does not mean a method can never change. A business may change a policy when a standard requires it or when the new method gives more reliable and relevant information, and IAS 8 then requires the change to be disclosed and the earlier year’s figures restated, so that the two years can still be compared. What consistency forbids is changing methods to make one year’s profit look better. The Framework puts consistency in its proper place. Consistency is the means, and comparability is the goal.⁶ A later chapter in this head teaches consistency and comparability together.

Consistency protects the comparison between years. Prudence protects the reader from a profit that is too rosy. The prudence convention, called conservatism in American books, says that when there is real doubt, the accountant should take care not to overstate assets and profit or understate liabilities and losses. Its traditional form was the saying already quoted: “anticipate no profit, but provide for all possible losses”. So stock is valued at the lower of its cost and the price it will sell for, and a debt that a customer is unlikely to pay is written off or provided for, as with the customer of Shahid’s who left the city owing Rs 40,000.

The old form of the rule had a fault, which the Framework of 2018 corrected. “Provide for all possible losses” invited managers to create large provisions for losses that were not likely, in good years, and then to release them in bad years to make profits look steady. That is not caution. It is bias in the other direction, and it misleads the reader just as much as overstating does. So the Framework now defines prudence as “the exercise of caution when making judgements under conditions of uncertainty”, which, it says, “means that assets and income are not overstated and liabilities and expenses are not understated”, and adds at once: “Equally, the exercise of prudence does not allow for the understatement of assets or income or the overstatement of liabilities or expenses.”⁶ Prudence is now there to support neutrality, not to bend the accounts towards gloom. A later chapter teaches it in full, with inventory and doubtful debts worked.

What matters and what must be told: materiality and disclosure

The materiality convention says that an item matters, and must be accounted for strictly and shown properly, only if leaving it out or getting it wrong could change the decisions of someone reading the accounts. A calculator costing Rs 1,200 will last ten years, so strictly it is an asset to be depreciated at Rs 120 a year. No banker or partner reading the shop’s accounts would decide anything differently if the whole Rs 1,200 were charged as an expense this year, so the shop may do that, and most businesses set a level below which small purchases are simply expensed.

Materiality is about the reader’s decision, not a fixed rupee figure. Rs 1,200 is immaterial to a shop with a profit of Rs 800,000, but a theft of Rs 1,200 by a director might be material because of what it says about the director. The Framework defines material information as information whose omission, misstatement or obscuring “could reasonably be expected to influence decisions” of the primary users, and calls materiality “an entity-specific aspect of relevance”.⁶ A later chapter teaches how size and nature both decide it.

Materiality tells the accountant what may be left out. Full disclosure tells them what must be put in. The full disclosure convention says that the accounts must show, in the statements or in the notes, everything a reader needs to understand them. A company that is being sued for a large sum, that has pledged its factory as security for a loan or that has changed its stock method must say so, even though some of these things are not yet recorded in the figures. The notes to a set of accounts often run longer than the statements themselves, and this convention is why.

The Framework does not use the old name, but its idea of a complete depiction says the same: “A complete depiction includes all information necessary for a user to understand the phenomenon being depicted, including all necessary descriptions and explanations.”⁶ The chapter on completeness and disclosure, later in this head, works the five disclosure cases that the CE-2022 paper set.

Beyond these four, two more rules sometimes appear on lists in this head. Substance over form says that a transaction is recorded according to its economic reality, not merely its legal shape. A machine leased for its whole working life is in substance the business’s own asset, bought with borrowed money, even though the lessor still owns it in law. The Framework puts this inside faithful representation, as you will see in section 7, and the syllabus gives it its own chapter at the end of this head. Neutrality says that the accounts must be free from bias, and it too has its own chapter. Both are on FPSC’s list for this head and will be taught there in full.

6. Where the rules came from

The rules in sections 3 to 5 were not written in one place or at one time. They grew over five centuries, and knowing roughly how helps you understand why they are sorted so untidily.

The oldest is double entry, the dual aspect principle, which grew up among the merchants of the Italian trading cities. Its best-known early account is in a book by Luca Pacioli, a Franciscan friar and mathematician who had worked for a merchant in Venice. His Summa de arithmetica, geometria, proportioni et proportionalita was published in Venice in 1494. Written in Italian, the language merchants read, it set arithmetic, algebra, tables of money and weights and a summary of geometry beside a treatise on double-entry bookkeeping.¹² Pacioli described a method that merchants already used, and his book helped it travel.

Most of the other rules grew up in the nineteenth and twentieth centuries, when companies with many shareholders became common and their accounts had to be trusted by people who never saw the business. The going concern assumption, historical cost, prudence and consistency became settled practice among British and American accountants, and courts and company laws came to expect them. They were customs before they were rules, which is why many of them are still called conventions.

In the second half of the twentieth century each country had its own accounting standards, and a company listed in several countries had to prepare its accounts several ways. In 1973 the professional accounting bodies of nine countries (Australia, Canada, France, Germany, Japan, Mexico, the Netherlands, the United Kingdom with Ireland, and the United States) formed the International Accounting Standards Committee, the IASC, to write standards that all could use. In 1989 the IASC published its Framework for the Preparation and Presentation of Financial Statements, the first international “conceptual framework”, which gathered the basic ideas into one document. In 2001 the IASC was replaced by a full-time board, the International Accounting Standards Board, which adopted the IASC’s standards and has issued the IFRS series since. In March 2018 the IASB issued the revised Conceptual Framework for Financial Reporting, the version in force today.¹¹

Pakistan’s part of the story is told in section 13. Its company law, now the Companies Act 2017, requires companies to prepare accounts that give a true and fair view and follow the standards the SECP notifies, and the standards it notifies are the IASB’s.⁹¹⁰

7. The Conceptual Framework of 2018, the modern home of the rules

The old list of principles, concepts and conventions is what most textbooks teach and what FPSC asked for in 2023. The modern home of those ideas is the IASB’s Conceptual Framework, and an answer that knows both scores better than one that knows only the old list. This section teaches what the Framework is and what it says. The next section shows where each old rule now sits in it.

What the Framework is, and what it is for

The Framework describes “the objective of, and the concepts for, general purpose financial reporting”. It exists to help the IASB write standards on consistent ideas, to help companies choose a policy when no standard covers a matter or a standard allows a choice, and to help everyone understand the standards. It is not itself a standard. In its own words, “Nothing in the Conceptual Framework overrides any Standard or any requirement in a Standard.”⁶ So if a standard and the Framework ever pointed different ways, a company would follow the standard.

The Framework matters directly to a company when there is no standard for a matter. IAS 8 then tells management to use its judgement to develop a policy that gives relevant and reliable information, and lists what reliable means: information that represents faithfully, reflects “the economic substance of transactions … and not merely the legal form”, is “neutral, i.e. free from bias”, is “prudent” and is “complete in all material respects”. It then tells management to look first at standards on similar matters and next at the Framework’s definitions and concepts.⁸ Substance over form, neutrality, prudence, completeness and materiality are all named in that one paragraph of IAS 8.

With its status clear, turn to what the Framework says. It begins with the purpose of financial reporting, because every other idea is judged by whether it serves that purpose. The objective is “to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions relating to providing resources to the entity”.⁶ Those decisions are about buying, selling or holding shares and bonds, and giving or settling loans. Notice who is named. They are the people who provide the money. A bank deciding on Shahid’s loan is exactly such a user.

What makes information useful, and the rest of the Framework

The Framework’s second chapter says what makes financial information useful, and it is the part most like the old list of conventions. There are two fundamental qualitative characteristics, relevance and faithful representation: “If financial information is to be useful, it must be relevant and faithfully represent what it purports to represent.”⁶

Information is relevant if it is “capable of making a difference in the decisions made by users”. It can make a difference by helping users predict the future (predictive value) or by confirming or correcting what they believed before (confirmatory value), and often by doing both. Materiality, as section 5 showed, is the part of relevance that is particular to each entity.⁶ The Part-I paper of CE-2025 asked when accounting information is relevant, and what its predictive value means, and both answers come straight from these paragraphs.³

Information is a faithful representation if it shows the substance of what it claims to show. The Framework says a perfectly faithful picture would be complete, neutral and free from error, and admits that perfection “is seldom, if ever, achievable”. It says that if the substance of an event and its legal form differ, information about the legal form alone would not be faithful, which is substance over form. It says neutrality “is supported by the exercise of prudence”, in the careful sense section 5 explained.⁶

Four enhancing qualitative characteristics make relevant and faithful information more useful: comparability, verifiability, timeliness and understandability. Comparability lets users see similarities and differences between items, and needs at least two of them; consistency helps to achieve it. Verifiability is the old objectivity. Timeliness means having the information in time to use it. Understandability means classifying and presenting it clearly, without leaving out complex matters merely because they are hard, since the accounts are written for users with a reasonable knowledge of business who study them with care.⁶ The Part-I paper of CE-2025 asked what comparability requires when two companies use different depreciation methods. The answer is not that they must use the same method. It is that each must disclose its method, so that the reader can allow for the difference, as IAS 16 requires.³

Over all these qualities sits one constraint, cost: “Cost is a pervasive constraint on the information that can be provided by financial reporting.” Reporting costs money, and the benefit of an item of information must justify its cost.⁶ This is the reason, for example, that a small company may follow simpler standards than a listed one.

The qualities are the Framework’s second chapter. Its other chapters hold the old assumptions and principles. The third chapter covers the reporting period, the going concern assumption and the reporting entity, so three of the four old assumptions live there.⁶ Its fourth chapter defines the elements of the statements. An asset is “a present economic resource controlled by the entity as a result of past events”; a liability is a present obligation to transfer an economic resource; equity is the residual after liabilities; income is “increases in assets, or decreases in liabilities, that result in increases in equity”, other than owners’ contributions; and expenses are the reverse.⁶ Its later chapters cover when an item is recognised, how it is measured (historical cost or a current value) and how it is presented. The next head of Paper-I, on the accounting cycle, puts the elements to work, and the third head has a chapter on the qualities of useful information.

8. How the old list maps onto the Framework

You now know two lists of the same ideas. The old one names fourteen rules; the Framework has an objective, qualitative characteristics, one assumption, and definitions of the elements and their measurement. Figure 3 joins them. Read it from the left. Each rule on the old list is linked to the part of the Framework where the same idea now lives.

Three things stand out. First, nothing on the old list was thrown away. Every rule found a home, although several were renamed. Second, the old assumptions and principles went mostly into the Framework’s chapters on the entity, the elements and measurement, while the old conventions went mostly into its chapter on the qualities of useful information. That is the same split you saw in Figure 1, between the ground and the pillars on one side and the roof on the other. Third, some old rules were changed as they moved. Conservatism became a careful prudence that forbids understating as firmly as overstating. Historical cost became one measurement basis among several. Objectivity became verifiability, which accepts a reasonable estimate.

In an exam answer, use this map in one or two sentences, not more. If a question asks you to define four accounting principles, define them as the old list does, and then add for each the Framework’s modern word. “The objectivity principle, which the 2018 Conceptual Framework calls verifiability” tells the examiner you know both the textbook and the standard.

9. How to apply a concept to the facts in a question

Knowing the rules is half the work. The other half, and the half Paper-I tests most, is applying them to the events of a business. You decide which rule settles each event, and what that does to the figures. The examiners of CE-2016 found candidates who treated a dividend as an expense and money received in advance as an asset.⁵ Both mistakes are failures to apply a concept. A dividend is a payment to the owners, which the entity assumption keeps out of expenses. Money received in advance has not been earned, so realisation makes it a liability. Here is a method that prevents such mistakes. Use it for every event in a list.

1. Say what happened, in money. Write the event in one line with its amount and date, and note where the cash went and when. (“Rent of Rs 45,000 paid on 25 June for July to September.”)
2. Ask which question the event raises. Is it about whose transaction this is (entity), whether it can be measured in money (money measurement), whether the business will carry on (going concern), at what amount to record it (historical cost), whether revenue has been earned (realisation), which period a cost belongs to (accrual and matching), whether it is too small to matter (materiality) or whether there is doubt to be careful about (prudence)?
3. Name the rule that answers that question, and state it in one sentence. (“Under the matching principle, a cost is charged in the period whose revenue it helps to earn.”)
4. Apply it to the facts and decide. (“The rent is for next year’s trading, so none of it is this year’s expense. It is a prepayment, an asset of Rs 45,000.”)
5. Show the effect on the figures. Say what changes in the income statement and in the balance sheet, and by how much. (“Expenses fall by Rs 45,000, so profit rises by Rs 45,000, and current assets rise by the same amount.”)

Steps 2 and 3 are where most marks are won. A candidate who jumps from the event straight to the answer may get the figure right, but has not shown the examiner why, and in a theory question the why is most of the marks. A candidate who names a rule without applying it to the facts has written a definition, not an answer. Step 5 is what Paper-I’s computations need, because a corrected profit is just the old profit plus or minus each step 5.

Two habits help. Take the events one at a time, in the order given, and number your answer to match. Keep a running total of the profit as you go, so that a slip in one line does not hide in a final figure. The worked case that follows does both.

10. A worked case, Shahid’s mobile shop

Here is the whole of the case from section 1. Shahid’s shop in Saddar ends its year on 30 June 2026. Bilal’s profit for the year was Rs 912,000. The accountant found ten matters in Bilal’s working. Follow each one through the five steps, and watch the profit move.

Matter 1. Shahid paid his home electricity bill of Rs 18,000 from the shop’s till, and Bilal charged it as a shop expense. The question is whose transaction this is, and the business entity assumption answers it. The shop’s accounts record only the shop’s transactions. The bill was for Shahid’s house, so it is his own expense, and paying it from the till is drawings. The expense is removed, so profit rises by Rs 18,000, to Rs 930,000. Shahid’s capital falls by the same Rs 18,000 as drawings.

Matter 2. Shahid believed his shop had become Rs 250,000 more valuable, and Bilal added that to profit. The question is at what amount to record assets, and historical cost answers it. Assets are recorded at what they cost and are not written up to an owner’s estimate. Realisation says the same thing from the revenue side, since nothing has been sold. The Rs 250,000 is removed, so profit falls to Rs 680,000.

Matter 3. Phones were sold on credit to a school for Rs 140,000 and delivered on 20 June; the school paid on 8 July. Bilal left them out. The question is whether revenue has been earned, and realisation answers it. A sale is recorded when the goods are delivered and the customer owes the money. These are June’s sales. Revenue rises by Rs 140,000, so profit rises to Rs 820,000, and the balance sheet shows a receivable of Rs 140,000. (The cost of those phones was already in the year’s purchases, and they were not in the closing stock count, so no other figure changes.)

Matter 4. A customer paid Rs 60,000 on 28 June for phones to be delivered on 5 July, and Bilal counted it as a sale. Realisation settles this one too. The goods have not been delivered, so nothing has been earned. The shop owes the customer the phones or the money back, so the Rs 60,000 is a liability, often called an advance from customers or a contract liability. Revenue falls by Rs 60,000, and profit falls to Rs 760,000.

Matter 5. On 25 June the shop paid Rs 45,000 rent for July, August and September, and Bilal charged it as this year’s expense. The question is which period the cost belongs to, and matching answers it. The rent is the cost of trading in the next three months. It is a prepayment, an asset. The expense is removed, and profit rises to Rs 805,000.

Matter 6. The staff’s salaries for June, Rs 35,000, were paid on 3 July, and Bilal left them out. Accrual answers this one. The work was done in June and helped earn June’s sales, so it is June’s expense, whenever it is paid. The expense is added and an amount owing (an accrued expense, a liability) is shown. Profit falls to Rs 770,000.

Matter 7. On 1 July 2025 the shop bought a display counter for Rs 96,000, expected to last eight years with nothing left at the end, and Bilal charged the whole cost as an expense. Matching settles this one too. The counter will help earn revenue for eight years, so its cost is spread over them. The Rs 96,000 is removed from expenses, and profit rises to Rs 866,000. The counter goes into the balance sheet as an asset at its cost.

Matter 8. The year’s share of the counter’s cost must now be charged. Rs 96,000 divided by eight years is Rs 12,000 of depreciation. Profit falls to Rs 854,000, and the counter appears in the balance sheet at Rs 84,000 (cost less one year’s depreciation).

Matter 9. Bilal recorded a calculator bought for Rs 1,200 as an asset and charged Rs 120 of depreciation, a tenth of its cost. The shop’s policy is to charge any item under Rs 5,000 straight to expenses. Materiality is the question, and the answer is that the calculator is too small to affect any reader’s decision, so the shop’s policy is acceptable and should be kept consistently. The full Rs 1,200 becomes an expense instead of Rs 120, so profit falls by Rs 1,080, to Rs 852,920.

Matter 10. A customer who owed the shop Rs 40,000 for phones bought in March has closed his business and left Rawalpindi, and cannot be traced. Bilal counted the Rs 40,000 as an asset. Prudence answers it. There is no realistic hope of payment, so the debt must not be shown as an asset. It is written off as a bad debt, an expense of Rs 40,000. Profit falls to Rs 812,920.

Look at what Figure 4 shows. The two largest corrections, the guessed rise in value and the credit sales left out, pull in opposite directions, and the net effect of all ten is a fall of Rs 99,080. A careless reader might think the corrections cancel out, but each one was a different mistake, and a different rule settled it. In an exam, the examiner gives marks for each line, not for the final figure. A candidate who reaches Rs 812,920 with no working gets far less than one who shows ten lines and makes a slip in one.

Notice, too, which corrections changed the balance sheet as well as the profit. Matter 3 created a receivable, matter 4 a liability to the customer, matter 5 a prepayment, matter 6 an accrued salary, matters 7 and 8 an asset at Rs 84,000, and matters 1 and 10 changed capital and receivables. A profit correction always has another side. That is the dual aspect principle at work, and it is why the corrected balance sheet will still balance.

11. Your turn with help, Nasreen’s boutique

Nasreen runs a boutique in Liberty Market, Lahore, that sells fabric and stitches dresses to order. Her year ends on 30 June 2026, and her own figure of profit is Rs 540,000. Six matters need checking. For each one, write down the rule that settles it and its effect on profit before you read the steps beside it.

Matter 1. A bride paid a deposit of Rs 75,000 on 10 June for a wedding dress to be delivered on 20 July. Nasreen counted it as a sale.

Your step: which rule, and what effect? The author’s step: realisation. The dress has not been delivered, so nothing has been earned, and the deposit is a liability to the bride. Revenue falls by Rs 75,000. Profit is now Rs 465,000.

Matter 2. For Eid, Nasreen’s family took clothes from the shop’s stock that had cost Rs 12,000. Nothing was recorded, and the clothes are simply missing from the closing stock count, so their cost has been charged in the cost of goods sold.

Your step: which rule, and what effect? The author’s step: business entity. The clothes went to the owner’s family, not to customers, so their cost is not an expense of earning the shop’s revenue. It is drawings. Taking Rs 12,000 out of the cost of goods sold raises profit by Rs 12,000, to Rs 477,000, and Nasreen’s drawings rise by Rs 12,000.

Matter 3. A sewing machine bought on 1 July 2025 for Rs 64,000 was charged as an expense. It will last eight years and be worth nothing at the end.

Your step: which rule, and what two effects? The author’s step: matching. The machine serves eight years, so its cost is removed from this year’s expenses (profit rises by Rs 64,000, to Rs 541,000) and one year’s depreciation, Rs 64,000 divided by eight, is Rs 8,000, is charged instead (profit falls to Rs 533,000). The machine stands in the balance sheet at Rs 56,000.

Matter 4. The electricity bill for June, Rs 9,500, arrived on 8 July and has not been recorded.

Your step: which rule, and what effect? The author’s step: accrual. The electricity was used in June to run the shop, so it is June’s expense. Profit falls by Rs 9,500, to Rs 523,500, and an accrued expense of Rs 9,500 appears as a liability.

Matter 5. Nasreen valued her closing stock of fabric at its selling price, Rs 130,000. It cost Rs 82,000.

Your step: which rules, and what effect? The author’s step: historical cost and prudence, together with realisation. The fabric has not been sold, so the profit on it has not been earned, and stock is valued at cost (or at what it will sell for, if that is lower). Closing stock falls by Rs 48,000, which raises the cost of goods sold by the same amount, so profit falls by Rs 48,000, to Rs 475,500.

Matter 6. Nasreen changed the way she values her stock this year, from the first-in-first-out method to the weighted average method, because her new accounting software only offers the second.

Your step: which rule, and does it change the profit here? The author’s step: consistency. A change made only for the convenience of software is not a good reason. If she does change, she must say so in the notes and show what last year’s figures would have been on the new method, so that the two years can be compared. No figure for the correction is given here, so the profit stays at Rs 475,500, but an accountant would raise the matter with her.

Her corrected profit is Rs 475,500, which is Rs 64,500 less than her own figure. If your answers differ, go back to the step where they parted and read the rule again.

12. Cases to do on your own

Try each case alone. Name the rule, apply it and give the effect. Then open the answer.

Case 1. Tariq, who owns a pharmacy, pays his son’s school fees of Rs 25,000 from the pharmacy’s bank account, and the bookkeeper records them under “staff welfare”.

Case 2. A company bought land in Gwadar for Rs 4 million in 2019. A property dealer now says it is worth Rs 9 million. The company uses the cost model for its land.

Case 3. A manager changes the company’s depreciation method every year, choosing each time the method that gives the steadiest profit.

Case 4. A trader delivers goods worth Rs 80,000 to a customer on 28 June. The customer pays on 15 July. The trader’s year ends on 30 June. In which year is the sale recorded?

Case 5. A factory in Faisalabad has lost its only customer and its bank has refused to renew its loan. The owners have decided to close the factory in three months and sell its machines.

Case 6. A company has just lost a court case and will almost certainly have to pay damages of about Rs 2 million. The managing director wants to wait until the judgment is paid before recording anything.

13. The rules as Pakistani law

Everything in this chapter so far could be taught in any country. What makes it law in Pakistan is the Companies Act 2017, and the way it brings in the international standards, which rest on the Framework.

The Act begins with the books of account. Every company must keep, at its registered office, books of account and financial statements for every financial year “which give a true and fair view of the state of the affairs of the company”.⁹ For the financial statements themselves, section 225 says they “shall give a true and fair view of the state of affairs of the company, comply with the financial reporting standards notified by the Commission and shall be prepared in accordance with the requirements contained in the Third Schedule”.⁹ The Commission is the SECP. So the Act does not list the principles and conventions one by one. It requires the standards, and the standards carry the rules.

The standards reach Pakistani law in five steps. ICAP’s Accounting Standards Board consults on a new IFRS standard; it considers whether any Pakistani law needs to change for the standard to work; it recommends adoption to the ICAP Council; the Council recommends it to the SECP; and the SECP decides, and notifies the standard in the official Gazette. Once notified, a standard has the force of law.¹⁰ Pakistan has adopted every IFRS Accounting Standard issued by the IASB except IFRS 1, the standard on first-time adoption, with a few exemptions and deferrals granted by the SECP and the State Bank. One example: companies and modarabas that use interest-free modes of finance apply the State Bank’s Islamic standard IFAS 2, Ijarah, instead of IFRS 16 on leases.¹⁰

Not every company follows the full standards. The Third Schedule to the Act sorts companies by size and type, because the cost of reporting must be justified by its benefit, as the Framework’s cost constraint says. The table below gives the frameworks.

A smaller company may choose a higher framework, so a small company may use IFRS for SMEs or the full IFRS, and a company’s class is fixed from its last audited accounts.⁹¹⁰ All three frameworks rest on the same assumptions and principles you have learned. Even the smallest company prepares its accounts on the accrual basis, at cost, as a going concern.

You can see all of this at the front of any Pakistani listed company’s accounts. Pakistan Oilfields Limited, whose registered office is at Morgah in Rawalpindi, opens the notes to its accounts for the year ended 30 June 2025 with a note headed “Basis of preparation”. It says the accounts “have been prepared in accordance with the accounting and reporting standards as applicable in Pakistan”, which are the IFRS standards “as notified under the Companies Act, 2017” and the Act’s own provisions and directives, and that where the Act differs from IFRS the Act has been followed. The next note says the accounts “have been prepared under the historical cost convention except as otherwise disclosed”, and the one after says they are presented in Pakistani rupees, the currency of the company’s business.¹³ Those three short notes are this chapter in practice: the standards, historical cost and money measurement, stated in a few lines before the figures begin. The auditor’s report then says whether the accounts “give a true and fair view”, in the words section 249 of the Act requires.⁹ The true and fair view has its own chapter later in this head.

14. What students mix up

Concepts and conventions are two different lists. They are not. They are two ways of describing the same rules, and books sort them differently. Define the word the question uses, then give rules that fit your definition.

Going concern means the business is making a profit. A business can make losses and still be a going concern, so long as it will carry on trading. Going concern fails only when the business intends or needs to close.

Historical cost means assets can never change in value in the accounts. Depreciation lowers them every year, impairment lowers them when their value has fallen, and IAS 16 lets a company revalue land and buildings if it chooses. What historical cost forbids is writing an asset up to a value an owner merely hopes for.

Prudence means making the accounts as gloomy as possible. The 2018 Framework says plainly that prudence does not allow understating assets or income or overstating liabilities or expenses. Hidden reserves made “to be safe” are bias, not prudence.

Accrual and cash basis give the same profit over time, so it does not matter which is used. Over a business’s whole life they do, but each year’s profit is different, and a year’s profit is what lenders, owners and the tax authorities use. That is the whole reason for the accounting period assumption.

The business entity assumption only applies to companies. It applies to every business, including a sole trader, though in law a sole trader and their business are the same person. It is an accounting assumption, not a legal one.

The Conceptual Framework is a standard that companies must follow. It is not a standard, and it overrides none. Companies follow the standards; the Framework guides the IASB and fills gaps where no standard applies.

Materiality is a fixed percentage of profit. Rules of thumb exist, but materiality depends on whether the item could change a reader’s decision, and an item can be material by its nature even when it is small.

15. What FPSC has asked

In Part-II, FPSC has asked about this head directly once since 2016, in the CE-2023 Paper-I, where Q.2 opened with two short parts of five marks each before a trial balance problem:²

• “(A) What are the Accounting Principles? Define any four accounting principles shortly.” (5 marks)
• “(B) What are the Accounting Conventions? Define any four accounting conventions shortly.” (5 marks)

Part-I asks about the rules by name more often. The CE-2025 Paper-I asked when accounting information is relevant, what its predictive value means, what comparability requires of two companies that use different depreciation methods, and which statement shows a sole trader’s drawings.³ The CE-2026 Paper-I asked how a credit sale affects the statements, what happens to the accounting equation when an owner brings her car into the business, and which principle matches expenses with revenue.⁴ Each of those has an answer in this chapter.

The rules are tested far more often without being named. Every Paper-I question that gives a trial balance and a list of adjustments asks you to apply accrual, matching, realisation, prudence and the entity assumption, line by line. The CE-2016 examiners’ complaint about dividends treated as expenses and advances treated as assets was a complaint about this chapter’s rules.⁵

16. Facts to carry into the hall

The four assumptions. Business entity, money measurement, going concern, accounting period.

The principles. Historical cost, realisation (revenue recognition), accrual and matching, dual aspect, objectivity.

The conventions. Consistency, prudence (conservatism), materiality, full disclosure.

The accounting equation. Assets = Liabilities + Capital (equity).

The Conceptual Framework. Issued by the IASB in March 2018. Not a standard, and overrides none. Objective: useful information for existing and potential investors, lenders and other creditors. Fundamental qualities: relevance (with materiality as part of it) and faithful representation (complete, neutral, free from error, supported by prudence). Enhancing qualities: comparability, verifiability, timeliness, understandability. Constraint: cost. Underlying assumption: going concern (paragraph 3.9).

Dates. 1494, Pacioli’s Summa with its treatise on double entry, Venice. 1973, the IASC formed by the accounting bodies of nine countries. 1989, the IASC’s Framework. 2001, the IASB’s first meeting. 30 May 2017, the Companies Act 2017 receives assent. March 2018, the revised Conceptual Framework.

Pakistan. Companies Act 2017, section 225: financial statements give a true and fair view and comply with the standards the SECP notifies. Pakistan has adopted every IFRS Accounting Standard except IFRS 1. Listed and large companies follow IFRS as notified; medium-sized companies IFRS for SMEs; small-sized companies ICAP’s Revised AFRS for SSEs.

Prudence in the Framework’s words. “Prudence is the exercise of caution when making judgements under conditions of uncertainty.”

17. What loses marks on this topic

The first is a list with no definitions. “Four accounting conventions are consistency, conservatism, materiality and disclosure” earns perhaps one mark of five. The question says “define”, so each convention needs a sentence saying what it requires and, ideally, a one-line example from a business.

The second is answering the wrong list. A candidate asked for conventions who writes going concern, entity, money measurement and accounting period has given four assumptions. Under some books’ sorting the examiner may accept one of them, but not all four. Open with your definition of a convention, so the examiner sees why your four belong under it.

The third is an example that does not fit the rule. “Under the matching principle, rent is paid every month” says nothing about matching. “Rent paid in June for July to September is next year’s expense, because it is the cost of trading in those months” shows the rule at work.

The fourth is the old form of prudence stated as today’s rule. “Provide for all possible losses” is what the old books said. A candidate who adds that the 2018 Framework forbids understating assets as firmly as overstating them shows they know the rule as it stands.

The fifth, in the computations, is the commonest of all: applying the cash basis by habit. Leaving out a credit sale because the cash came later, or charging rent paid in advance as this year’s expense, costs the marks for that line and every total below it.

18. A worked answer plan for CE-2023

The CE-2023 Paper-I Q.2 gave ten marks to parts (A) and (B) and the rest to a trial balance problem.² At about 37 minutes for a twenty-mark question, ten marks are worth about 18 minutes, so give each part nine minutes and about a page. Here is a plan for both parts, with the opening sentences written out as a model.

Part (A). What are the accounting principles? Define any four.

Open with a definition of the word: Accounting principles are the rules of recording that decide what is recorded in the accounts, at what amount and when. They rest on the basic assumptions of accounting, and today they are set out in the IASB’s Conceptual Framework (2018) and the standards built on it.

Then four principles, each in three sentences: what it says, why, and a short example.

1. Historical cost. Assets are recorded at the price paid for them, including the cost of making them ready for use. The cost is a fact that can be checked from an invoice, whereas a market value is an opinion. A counter bought for Rs 96,000 is recorded at Rs 96,000, even if a dealer later offers more.
2. Realisation. Revenue is recognised when it is earned, which for goods is normally when they are delivered to the customer. Goods delivered on 28 June and paid for on 15 July are the sales of the year ending 30 June. Money received in advance is a liability until the goods are delivered.
3. Matching (accrual). The expenses of a period are the costs used up in earning that period’s revenue, recorded when they are incurred rather than when they are paid. Salaries earned in June but paid in July are June’s expense.
4. Dual aspect. Every transaction has two equal effects, so that assets always equal liabilities plus capital. Buying stock on credit raises both stock and creditors.

Close with one sentence linking them to today’s rules: The Conceptual Framework (2018) keeps these ideas under its definitions of the elements, its measurement bases and the accrual basis of accounting.

Part (B). What are the accounting conventions? Define any four.

Open with the definition: Accounting conventions are customs that accountants have long followed and generally accept, which guide the judgements the principles leave open.

Then four conventions, three sentences each.

1. Consistency. A business keeps to the same methods from year to year unless a change gives more reliable information, and discloses any change. It makes one year comparable with the next; the Framework calls consistency the means and comparability the goal.
2. Conservatism (prudence). When there is uncertainty, assets and income are not overstated and liabilities and expenses are not understated. Stock is valued at the lower of cost and net realisable value. The 2018 Framework adds that prudence does not allow the opposite bias either.
3. Materiality. An item matters only if leaving it out or misstating it could change a user’s decision. A calculator costing Rs 1,200 may be charged as an expense at once instead of depreciated.
4. Full disclosure. The accounts disclose, in the statements or the notes, everything a user needs to understand them, such as a large lawsuit or a change in method.

If time allows, add one closing sentence: Some books treat these as concepts or constraints rather than conventions; the Framework places them among the qualities of useful information. That sentence shows the examiner you know why the lists differ, and costs half a minute.

What to remember from this chapter

• The rules of accounting are agreements that make accounts comparable. Without them two honest people would report different profits for the same business, as Bilal and the accountant did for Shahid’s shop.
• An assumption is taken as true so that accounts can be prepared at all; a principle is a rule of recording; a convention is an accepted custom that guides judgement; a concept is the general word. Books sort the same rules differently, so define the word the question uses.
• The four assumptions are business entity, money measurement, going concern and the accounting period.
• The principles are historical cost, realisation, accrual and matching, dual aspect and objectivity. The conventions are consistency, prudence, materiality and full disclosure.
• The IASB’s Conceptual Framework (2018) is the modern home of all of them. It is not a standard. Its objective is useful information for investors, lenders and other creditors, and its qualities are relevance and faithful representation, enhanced by comparability, verifiability, timeliness and understandability, under the constraint of cost.
• Prudence today means caution, not gloom. It forbids understating assets and income as firmly as overstating them.
• To apply a rule to an event: say what happened in money, ask which question it raises, name the rule, decide, and show the effect on the figures.
• In Pakistan, section 225 of the Companies Act 2017 requires accounts that give a true and fair view and follow the standards the SECP notifies. Pakistan has adopted every IFRS except IFRS 1, and smaller companies follow IFRS for SMEs or ICAP’s standards for small entities.

Check yourself

Answer each in your own words before you open the answer.

1. What is the difference between an assumption and a convention? Give one example of each. (The section on the four words.)

2. A shop pays its owner’s car insurance from the business bank account and records it as an expense. Which rule is broken, and what is the correction? (The section on the assumptions.)

3. What did the 2018 Conceptual Framework change about prudence, and why? (The section on the conventions.)

4. Name the two fundamental and the four enhancing qualitative characteristics in the Conceptual Framework. (The section on the Framework.)

5. A trader’s profit, before corrections, is Rs 300,000. Rent of Rs 24,000 for the next year was charged this year, and wages of Rs 10,000 for the last week of the year are unpaid and unrecorded. What is the corrected profit? (The worked case.)

6. Which law makes a Pakistani company follow the international standards, and what does it require? (The section on Pakistani law.)

7. From the chapter on how to sit the papers: about how many minutes should a ten-mark part of a Part-II question get, and why?