Accounting Assumptions

Assumptions 

There are four key assumptions in accounting: economic entity, going concern, monetary unit, and periodicity. 

Economic Entity Assumption

This assumption asserts that economic activity can be identified with a specific unit of accountability, such as a company or organization. Note, this is not the same as a legal entity. 

It requires that a business’s financial transactions be recorded separately from those of its owners and other entities. This assumption allows users of financial statements to distinguish between different entities and assess their financial performance. 

Going Concern Assumption

The going concern assumption assumes that a business will continue to operate indefinitely unless there is evidence otherwise. This assumption underpins most accounting methods and allows for normal GAAP reporting.

It implies that assets are reported at historical cost rather than liquidation value. For instance, depreciation and amortization are applied assuming the business will continue operating, and assets and liabilities are classified as current or noncurrent based on the assumption of continued operations.

An example of the going concern assumption can be seen in Marathon Digital’s SEC filings. Marathon is a bitcoin mining company that had a debt instrument with Silvergate Bank. Prior to the collapse the Company states that Silvergate may not be able to “operate as a going concern,” which indicates that their creditor is not going to remain operational into the future. And sure enough, 7 days later on March 8, the lender shutdown operations. This is important not only for Silvergate Bank to disclose, but also, equally important to those that are debtors to the bank to disclose as it is material information. 

Monetary Unit Assumption

The monetary unit assumption holds that money is the basis for measuring economic activity. This assumes stability of the monetary unit (e.g., the U.S. dollar) and assumes that changes in the purchasing power of money due to inflation or deflation are ignored for accounting purposes. This means that we can directly compare revenue in 2010 with revenue in 2025 without worrying about inflation/deflation. In essence, it enables straightforward measurement and comparability of financial transactions.

Periodicity Assumption

The periodicity assumption suggests that financial activities of a business can be divided into artificial time periods (e.g., monthly, quarterly, or yearly) to provide timely and meaningful financial information to users.

Financial statements are prepared periodically to provide users with relevant information for decision-making and evaluation. The shorter the reporting period, the more challenging it may be to ensure accuracy and reliability of financial information.