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Accounting Principles and concepts?


Introduction Unlike in the past when accounting statements were large needed by the proprietor these
days the accounting statements are needed by various parties who have vested interest in the business,
namely, proprietors, investor, creditors, government and many others, accounting statements disclose the
profitability and solvency of the business to various parties. It is therefore necessary that such statements
should be prepared according to some standard language and set rules. These rules are usually called
Generally Accepted Accounting Principles (GAAP). These principles have been generally accepted by
accountants all over the world as general guidelines for preparing the accounting statements.

Accounting Principles- Accounting principles may be defined as those rules of action adopted by the
accountants universally while recording accounting transaction. They are a body of doctrines commonly
associated with the theory and procedures of accounting, serving as an explanation of current practices
and as a guide for selection of conventions or procedures where alternatives exist. These principles can
be classified into tow categories: (1) Accounting Concepts (2) Accounting Conventions.
Accounting Concepts- Accounting Concepts are also self-evident statements or truths. Accounting
concepts are so basic that people accept them as valid without any questioning. Accounting concepts
provide the conceptual guidelines for application in the financial accounting process, i.e., for recording,
measurement, analysis and communication of information about an organization. The concepts are
important because they (a) help to explain the why of accounting (b) provide guidance when new
accounting situation are encountered, and (c) significantly reduce the need to memorize accounting
procedures when learning about accounting.
a) Separate Business entity Concept- According to this assumption business is treated as a unit
separate and distinct from its owners, creditors, managers and others. In other words, the owner
of a business is always considered as distinct and separate form the business he owns. The
proprietor is treated as creditors of the business to the extent of capital invested by him in the
business. The capita (Rs. 10000) is treated as liability of the firm. Similarly, the amount
withdrawn (Rs. 2000) by the proprietor from the business for his personal use is treated as is
drawings. Thus, net amount payable by the business will be shown only as Rs. 8000.
b) Money Measurement Concept- Only those transactions and events are recorded in accounting
which is capable of being expressed in term of money. An event even thought it may be very
measured in terms of money with a fair degree of accuracy. For example, if a business owns Rs.
10000 of cash, 600 kg of raw material two trucks, and 1000 square feet of building space etc.,
these amounts can not be added together to produce a meaningful total of what the business
owns. However, if these items are expressed in monetary terms such as Rs. 10000 of cash. Rs.
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12000 of raw material, Rs. 200000 of trucks and Rs. 50000 of building, all such items can be
added and much more intelligible and precise estimate about the assets of the business will be
available.
c) Going concern concept- As per this concept, it is assumed that the business will continue to
exist for a long period in the future. It is on this assumption that we record fixed assets at their
original cost and depreciation is charged on these assets without reference to their market value.
For example, if machinery is purchased which would last say, for the next 10 years, the cost of
this machinery will be spread over the next 10 years for calculating the net profits or loss of each
year. Because of the assumption of going concern the full cost of the machine would not be
treated as an expense in the year of its purchase itself. The market value of the fixed assets is
irrelevant and is not recorded in the balance sheet, as these assets are not going to be sold in the
near future.
d) Accounting period concept- As the business is intended to continue indefinitely for a long
period, the true results of the business operations can be ascertained only when the business is
completely wound up. But the users of the financial statements need to know the results of the
business at frequent intervals. Thus the entire life of the firm is divided into time-intervals for the
measurement of the profits of the business. Twelve month period is usually adopted for this
purpose. Accounting to the amended income tax law, a business has compulsorily to adopt the
financial beginning on 1st April and ending on 31st March in the next calendar year, as its
accounting period.
e) Dual Aspect Concept- According to this principle, every business transaction is recorded as
having a dual aspect. In other words, every transaction affects at least tow accounts, if one
account is debited, any other account must be credited. The system of recording transactions
based on this principle is called as Double Entry System, It is because of this principle that the
two sides of the balance sheet are always equal and the following accounting equations will
always hold good at any point of time-
Assets= Liabilities+ Capital
For example, X commences business with Rs. 5 Lac in cash and takes a loan of Rs. 1 Lac from
the bank, and these 6 Lac are used in buying some assets, say plant and machinery. The equation
will be as follows-
Assets= Liabilities + Capital
Rs. 6 Lac = Rs. 1 Lac + Rs. 5 Lac
f) Cost Concept- According to this principle, is that an asset is recorded in the books at the price
paid to acquire it and that this cost is the basis for all subsequent accounting for the asset. This
concept does not mean that the asset will always be shown at cost but it means that cost
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becomes basis for all future accounting for the asset. Assets is recorded at cost at the time of its
purchase is systematically reduced in its value by charging depreciation. For example, if a
business buys a plot of land for Rs. 50000, the asset would be recorded in the books at Rs. 50000
even if its market value at that time happens to be Rs. 60000. In Case a year later the market
value of this asset comes down to Rs. 40000, it will ordinarily continue to be shown at Rs. 50000
& not at Rs. 40000.
g) Matching Concept- This principle is very important for correct determination of net profit.
According to this principle, in determining the net profit from business operations, all costs
which are applicable to revenue of the period should be charged against that revenue.
Accordingly for matching costs with revenue, first revenues should be recognized. For example
if a salesman is paid commission in January, 1999, for sales made by him in December 1998, the
commission paid to the salesman in January, 1999, should be taken as the cost for sales made
him in December-1999,. This means that revenues of December-1998 (i.e. Sales) should be
matched with the cost incurred for earning that revenue (i.e. Salesmans Commission) in
December, 1998 (though paid in January, 1999)
h) Accrual Concept- According to this concept expenses are recognized in the accounting period in
which they help in earning the revenue whether cash is paid or not. Thus to ascertain correct
profit or loss for an accounting period and to show the true and fair financial position of the
business at the end of accounting period, we make record of all expenses and incomes relating to
the accounting period whether actual cash has been paid or received or not. Therefore, as a result
accrual concept, outstanding expenses and outstanding incomes are taken into considerations
while preparing final accounts of a business entity.
i) Realization Concept- Accounting to realization concept revenue is recognized when sale is made.
Sale is considered to be made at the point when the property in goods passes to the buyer and he
becomes legally liable to pay. This implies that revenues is generally realized when goods are
delivered or services are rendered.
j) Verifiability and objectivity of evidence concept- This concept means that all accounting
transaction that are recorded in the books of accounts should be evidenced and supported by
business documents. These supporting documents are cash memos, invoices, vouchers, bills
receivables, bills payables, agreements etc. Also these documents provide a base for audit.
k) Legal aspect concept- This concept implies that the accounting records and books should reflect
the legal position and the accounting records statements should conform to legal requirements.
The accounting records should be kept and the statements should be prepared in the manner
provided by law.
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Accounting Conventions- The term convention denotes circumstances or traditions, which guide the
accountants while preparing the financial statements. Concepts and conventions are often used
interchangeably. The basic difference between them is that concepts are concerned with maintenance of
accounts whereas conventions are applicable while preparing financial statements. Accounting convention
refers to customs, traditions, usages or practices followed by accountants as a guide in the preparation of
financial statements.
a) Convention of Conservatism- According to this principle, all anticipated losses should be recorded in
the books of accounts, but all anticipated or unrealized gains should be ignored in other words,
conservatism is the policy of playing safe. Provision is made for all known liabilities and losses even
though the amount cannot be determined with certainty. For example, closing stock is valued at cost or
market price whichever less is and provisions for doubtful debts is created in anticipation of actual bad-
debts.
b) Convention of full disclosure- This principle requires that all significant information relating to the
economic affairs of the enterprise should be completely disclosed. In other words, there should be a
sufficient disclosure of information which is of material interest to the users of the financial statements
such as proprietors, present and potential creditors, investors and others. For example, various items or
facts which do not find place in accounting statements are shown in the balance sheet by way of
footnotes like Contingent liabilities.
c) Convention of materiality- According to this principle, items having an insignificant effect or being
irrelevant to the user need not be disclosed. These unimportant items are either left out or merged with
other items, otherwise accounting statements will be unnecessarily overburdened. For example, an
ordinary calculator costing Rs. 100 may last for ten years. However, the effort involved in allocating its
cost over the ten year period is not worth the benefits that can be derived from this operation. The cost
incurred on calculator may be treated as the expense of the period in which it is purchasing. The
companies Act also permits ignoring of paise while preparing financial statements. Similarly for tax
purposes. The income has to be rounded to nearest ten.
d) Convention of consistency- This principle states that accounting principles and methods should remain
consistent or unchanged from one year to another. If a firm adopts different accounting principles in
two accounting periods, the profits of current period will not be comparable with the profits of the
preceding period. For example a firm can choose any one of the several methods of depreciation, i.e.,
straight line method, written down value method or any other method. But it is expected that the
method once chosen will be followed consistently year after year. Likewise, the method of stock
valuation or making provision for likely debts should remain consistent with the previous years
otherwise the decisions taken on the basis of accounts will be misleading.