Accounting Principles -Concepts

and Conventions
 Accounting Principles
Principle
• general law or rule adopted or professed as a
guide to action
• Includes practices, procedures, methods,
techniques, concepts and conventions in
accounting.
Accounting Principles are acceptable, if they satisfy the following
basic norms :
1) Relevance – refers to the usefulness of accounting data
generated.
2) Objectivity – An accounting principle is said to be objective
when it cannot be influenced by the personal bias and
whims.
3) Feasibility – Accounting principle must be practicable. Cost
Benefit Analysis.
4) Flexibility
Accounting principles are developed for common usage to
ensure uniformity and understandability.
Accounting principles are usually concepts and
conventions which have been adopted as a
general guide by the accountancy
professional.
Concepts – a concept is a notion, an idea. It
denotes the basic assumptions or propositions
or predictions or conditions upon which
accounting is based.
Accounting concepts are such ideas as are commonly
associated with the theory and practice of
accountancy. Concepts can be classified into 4
categories as follows.
a) Natural – i.e. matching cost with revenue is a
natural concept.
b) Real i.e. practical eg. prov for RDD
c) Ideal i.e. theoretical
d) Borrowed concepts
• Convention – denotes customs or traditions.
It refers to a statement or rule of practice which, by
common consent express or implied, is employed
in the solution of a given class of problems or
guides behaviour in a certain kind of situation.
Conventions are established usages or rules or
statement of practice.
Eg. Debit on left hand side, liability on left hand
side, expenditure on left hand side etc.
 Accounting Concepts

1. Business/Separate Entity Concept

2. Dual Aspect Concept
3. Money Measurement Concept
4. Going Concern Concept
5. Cost concept
6. Cost Attach concept
7. Matching costs and revenue concept
8. Realisation Concept
9. Accrual Concept
10.Accounting Period Concept
 Accounting Conventions
1) Conservatism
2) Consistency
3) Materiality
4) Disclosure
5) Objective Evidence
 1) Business Entity Concept
• A firm or business is regarded as separate and distinct
from the owner.
• All transactions pertaining to business are recorded
separately without mixing the private transactions of
the owner.
• Proprietor is considered a creditor and his capital is
shown as a liability for the business.
• Any amount/goods withdrawn by the proprietor are
treated as drawings and reduced from his capital
account.
Following Accounting Equation is the expression
of the entity concept
Assets = Liabilities + Capital
The above equation shows that the business
itself owns the assets and in turn owes the
various claimants.
 2) Dual Aspect Concept
• Every business transaction has dual effect i.e.
twofold effect i.e. first receiving of the benefit
and second giving of that benefit.
• For every receiver, there must be a giver.
• So there must be a double entry to have a
complete record of each business transaction.
• Thus every debit must have a corresponding
credit.
For eg. Mr. X started his business with cash Rs.
1,00,000 and purchased Plant and machinery
worth Rs. 5,00,000 and furniture worth Rs.
1,00,000. Thus he has provided Rs. 7,00,000 to
business.
Assets = Equities (or Liabilities + Capital)
Cash + P & M + Fur = Capital
Subsequently, if the business purchases stock
worth Rs. 80,000/- on credit, position will be
as under.
Cash 100000 + P & M 500000 + Furniture
100000 + stock 80000 = Capital 700000 +
creditors 80000
Thus, we see that
Assets = Liabilities + Capital
 3) Money Measurement Concept
• All transactions are recorded in terms of money.
• Money – used as a measuring unit for financial
reporting
• Money acts as a means of indicating the value of
the commodity or prices.
• Thereby simplifies the business of calculating the
rate at which one commodity can be exchanged
for another.
• This concept makes accounting information
more meaningful and useful for analysis of
financial statements.
• Measurement of business events in monetary
terms helps in understanding the exact state
of affairs of the business in much better way.
• For eg. A business unit has the following assets on 31st
Dec 10
Capital Rs. 1,00,000
Cash in hand Rs. 5,000
Motor Cars 2 Nos.
Stock 100 Tons
Furniture 10 Tables and 50 Chairs
Land 5 Acres
The above items are different in units and therefore they cannot
be added together to get the idea of total value of assets
• If we express all above items in terms of
money, we get a clear picture of the assets of
business as under
Capital Rs. 1,00,000
Cash in hand Rs. 5,000
Motor Cars Rs. 3,00,000
Stock Rs. 50,000
Furniture Rs. 30,000
Land Rs. 5,00,000
Total Rs. 9,85,000/-
Limitations of money measurement concept
1) The value of money is not constant. It may change
due to inflation or deflation in the country.
2) It restricts the scope of accounting because all
business assets cannot be measured in money terms.
It is very difficult to calculate the value of goodwill,
or measure the efficiency of employees or measure
the efficiency of management, sales and pricing
policy of management, working conditions etc.
 4) Going Concern Concept
• Also called as the “Concept of permanency” or
“continuity concept”
• Assumed that the business will last for a long time
and there will be no intention of closing down the
business.
• It will continue to operate in future and
transactions are recorded from this point of view.
• Going concern concept ensures a long life of the
business.
 Main implications of a going
concern concept
• The assets acquired need not be sold and are not
meant for resale.
• The expenditure is classified into capital and
revenue.
• The revenue income is compared with revenue
expenditure to ascertain the results from
business.
• The assets are recorded at cost and shown in the
balance sheet at cost less depreciation
• Deferred revenue expenditure and unexpired costs are
carried forward to the next year.
• The fluctuations in the market rates are ignored.
Exceptions
1) In case of liquidation, realisation value may be taken
into consideration.
2) In case of contractual commitments, the cost of
equipment purchased is charged to that contract, even
though the same equipment may be useful for a longer
period.
 5) Cost Concept
• Is closely related to going concern concept.
• Adopted for the purpose of convenience and
feasibility.
• All transactions and events are recorded in
the books of accounts at the actual price
involved.
• Acquisition cost is considered highly reliable,
definite and free from bias.
Limitations of cost concept
1)Depreciation is computed on historical cost.
This understates the depreciation when
current value of the asset is high. So
revaluation of asset is necessary.
2)When the prices of all commodities are rising
continuously, the financial accounts will not
depict the true picture of business.
3) This concept ignores managerial competence,
reputation or goodwill, efficiency of
employees as they cannot be expressed in
terms of money.
4) Inter firm comparision becomes difficult.
While considering the above limitations as such
it is recommended to adhere to the cost
concept only.
 6) Cost Attach Concept

Total Cost = Material Cost + Labour Cost +

Overhead Cost
When appropriate portion of material costs,
labour costs and other overhead costs are
added or merged together, product costs are
obtained.
Also known as “Cost Merge Concept”
 7) Matching Costs with Revenue
concept
• Also called as periodic matching of costs with revenues.
• Accounts should be presented at fixed intervals
regularly.
• Revenue and cost incurred to obtain that revenue
should be properly matched.
• This helps in measuring the business performance
periodically.
• For eg. Profit = Sales Value – Total Cost
• Or Loss = Total Cost – Sales Value
• Following points to be considered for this concept
1)Revenue is considered to be earned on the date of
transaction and not on the date at which payment is
realised.
2)The purchase price of fixed assets is not taken but only
depreciation on fixed assets related to that accounting
period is taken.
3) Expenses paid in advance are excluded from
the total cost.
4) Outstanding expenses are added to the total
cost to arrive at the cost attached to that
period.
 8) Realisation Concept
• The profit on sale is generally regarded as
earned at the time when the goods or services
are passed on to the purchaser and the
purchaser incurs the liability for that.
• No profit is considered to have been earned
till it is either realised in cash or the other
party involved is legally liable to pay the
amount for sale of goods.
• For eg.
1)Cash sales of Rs. 10,000/-, here the income is recd in
cash.
2)Credit sales of Rs. 50000/-, here the seller creates a
legal right to receive the income. Thus, though the
income is not recd in cash, still is said to be realized.
• Exceptions
1)Income like interest, rent etc. are credited to
profit and loss account on accrual basis, though
they are not realised.
2)In case of hire purchase system, ownership of
the goods passes to the buyer, when he pays
the last instalment. But sales are presumed to
have been made to the extent of cash received
by way of instalment.
 9) Accrual Concept
• Also known as “Mercantile System of Accounting”
• Revenue is recognised at the time of sale rather than
at the time of collection of cash.
• It is a system of recording revenues whether they are
received in cash or not and expenses whether they
are paid in cash or not.
• Outstanding, prepaid, pre-received expenses and
income are considered under this concept.
• Because of this concept, the net profit or loss
of any period cannot be equal to
corresponding cash increase or decrease.
• For this purpose, the necessary entries will be
passed at the end of accounting year in
respect of following items:
a) Income earned but not received
b) Income received in advance
c) Income received but pertaining to previous
year
d) Expenses due but not paid
e) Expenses paid but not related to accounting
period.
 10) Accounting Period Concept
• The life of the business is divided into
appropriate segments for studying the result of
each segment.
• The life of business as per going concern is
indefinite and therefore the businessman after
each segment or time interval must “Stop” and
“See back” how things are going on. Such
segment or time interval is called as accounting
period.
• This concept indicates that the profitability of
a business is to be measured periodically.
• The period for which income is measured is
termed as accounting period.
 Accounting Conventions
1) Conservatism
“Anticipate no profit but provide for all possible
losses”
Also known as prudence concept implying the
common and accepted behaviour of accounting
Eg. Closing stock is valued at cost or market price
whichever is lower,
creating a provision for doubtful debts,
• Following are the conservative practices adopted
in accountancy
1)FA are shown are cost less depreciation.
2)CA are shown at cost or market whichever is less.
3)Charging stock of medicines, stationery to profit
and loss account.
4)Providing for doubtful debts and discount of
debtors
 2) Consistency
• The continuous application of the same
accounting policy enables to compare results.
• Helps in preparing more reliable, comparable
and dependable financial statements.
• Consistency does not mean inflexibility or
forbidding introduction of improved
accounting techniques.
Consistency has to be followed in particular in
respect of the following procedures
a)Calculation of Depreciation
b)Valuation of material
c) Treatment of revenue and capital expenditure
Consistency helps comparison of results. Once a
method or policy is adopted by the business it
should be consistently followed.
 3) Materiality
• Materiality means the relative importance and is
related to the convention of disclosure.
• Disclosure is necessary in financial accounts only for
material facts.
• The cost of accounting a transaction should not be
more than recording the transaction.
• What is material and what is not will be decided by
individual judgement.
• materiality may differ from concern to concern and
year to year.
 4) Full Disclousre
• All material facts should be disclosed in the
final accounts.
• The object of disclosure is to make the financial
statements more useful and to give less scope
for misinterpretation.
• Significant events occurring after the end of
the accounting year but before the preparation
of balance sheet are to be disclosed.
Important items requiring disclosure are as under :
1) Contingent Liabilities
2) Accounting methods and policies adopted by the
company.
3) Changes in the method or policies of accounting and
their consequences on the profit.
4) Items of non-recurring nature.
5) Significant difference between the cost and market
value of stock.
5) Objective Evidence