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Boundary rules

In small firms, financial information can be obtained from the business owner. In a large organisation, this is often impractical, so a more formal way of reporting back to the owner has to be devised.

It would be challenging to inform the owner about everything that had happened to the business, so a limit has to be placed on what should and should not be reported. This has resulted in the development of boundary rules, which comprise several concepts.

The entity concept

An entity is considered as something that maintains a separate existence. In business, an entity is an organisational structure that has its own goals, procedure and records. Examples include a sole proprietorship, a partnership and a corporation.

The aforementioned examples have names that may differ from the names of their owners and can independently own assets and incur obligations, though some entity structures (such as the sole proprietorship and some forms of partnership) may allow owners to also be liable for the obligations of their business entities.

An entity may also be required to submit tax returns and pay the government for their incomes earned.

In construction accounting, transactions are recorded and financial statements are produced for a specific entity. The private affairs of the owner are kept strictly separate from the affairs of the business.

The periodicity concept

Periodicity means that an organisation (entity) can report its financial results within a certain selected time period, ie this is the time when an entity consistently reports its results and cash flow. This could be on a monthly, quarterly or annual basis, but these time periods must be kept the same over time, for the sake of comparability.

For example, if the reporting period of a construction firm for the current year is set at October, then the same period should be adopted in the coming year so that the results of the two years can be compared on a month-to-month basis.

The main issue with periodicity is knowing when to produce the entity’s financial statements (monthly or quarterly). In most construction firms, financial statements are produced monthly so as to gain feedback on operational results.

Going concern

Going concern is the assumption that an organisation (entity) will stay in business for the foreseeable future. Conversely, this means that the entity will not be forced to stop operating and shut down its assets in the near term at what may be very low ‘fire-sale’ prices.

By making this assumption, the accountant is justified in deferring the recognition of certain expenses until a later period, when the entity will presumably still be in business and using its assets in the most effective manner possible.

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This article is from the free online course:

An Introduction to Financial Management in Construction

Coventry University