Accounting Principles

Submitted toDr. Meru sehgal

Submitted bySarabpreet Batra MBE- 1st semester Roll number- 8101

Definition: Guidelines to establish standards for sound accounting practices and procedures in reporting the financial status and performance. Based on1.Common experience 2.Historical precedents 3.Statements by individuals and proff. bodies 4.Regulations by govt.

Nature of accounting principles.

Uniform. Lack of universal applicability (not lab-tested like physics and chemistry) Are bound to change with changing business environment. Acceptance depends on the satisfaction of 3 basic criteria-

1.Relevance- useful information to the users. 2.Objective- Free from personal bias, verifiable. 3.Feasibility- applied without undue complexity and cost.

Need for accounting principles.

Makes the information reliable and comparable, hence increasing utility. Inter-firm, inter-industry, and time based comparisons possible. GAAP bring uniformity and consistency to the process of accounting.

Accounting principles can be divided into 1. Accounting postulates and concepts. 2. Accounting conventions.

Accounting concepts definitionHendriksen says, the accounting postulates/ concepts are the basic assumptions or fundamental propositions concerning the economic, political, and sociological environment in which accounting must operate.

1.Business Entity Concept-- Owner separate from business Absence mixes up private and business affairs. True picture not disclosed. Applicable to all forms of business organization.

ExampleWhen cash is received from the proprietorCash a/c Dr. To Capital a/c. That is cash account is debited and proprietors personal a/c is credited, like a loan to the business.

2.Money measurement concept

Only those transactions are recorded that are interpreted in terms of money. Helps in understanding the state of affairs of a business. General health conditions, strikes, working conditions etc do not find a place in accounting.

Example-a business has Rs. 5000 cash, 100meter square land, 20 tables. This information doesnt help because of lack of common unit but if a business hasRs. 5000 cash, land- Rs.100000, tablesRs.2000. Then this info is of vitality for the business.

3.Historical cost concept.

Transactions recorded at the actual amount involved. Asset however will be shown at cost less depreciation for the coming years. If nothing has been paid for acquiring the asset it will not be shown in the books of accounts.

ExampleLand worth Rs. 100000 bought on 1st august. Entry made on 2nd august, accountant estimates value 120000 on 2nd august. Recording at Rs. 100000 and not 120000.

4.Going concern.
Business will continue for a long time. Clear distinction made b/w assets and expenses. Pre-paid expenses treated as assets. Because of this concept suppliers supply goods and services and credit.

5.Dual aspect concept

Every transaction has two aspectsDebit and Credit. ASSETS= LIABILITIES + CAPITAL
Equation holds true hence implying every debit has a credit.

ExampleGoods worth Rs. 5000 are bought. Effect- stock increases by Rs. 5000 cash decreases by Rs. 5000.

6. Realization concept
Revenue realized when sale is made. Cash has been received or legal obligation to pay has been assumed by the customer. Prevents inflation of profits.

7.Objectivity concept
Accounting based on objective evidence. Supported by verifiable documentsvouchers, bills. Easier for auditors. Evidence should not be biased. Hence assets shown at historical cost 1st then at cost less depreciation.

8.Accounting period
To take corrective timely action statements prepared periodically at frequent intervals. 12 month period under Companies Act and Banking Regulations Act. Generally 1st April to 31st March. Also prepared bi-annually or quarterly called INTERIM accounts. Not for outsiders.

9.Matching concept
All costs chargeable to revenue must be charged to find out net income. =R - E Where, = profit, R = total revenue E= total expenses.

10.Accrual concept
Any transaction affects assets and liabilities even if settlement in cash will be at a later stage. All transactions are recorded- in cash or on credit. Called mercantile accounting. Helps in correct determination of profits, assets and liabilties.

Accounting conventionsDefinitionA custom or generally accepted practice adopted by either general agreement or common consent among accountants. 1.Convention of materiality 2.Convention of prudence 3.Convention of full disclosure 4.Convention of consistency

Difference b/w concepts and conventions.

Concepts are established by law and conventions are based on custom, usage or agreement. No role of personal judgement in concepts. Concepts are uniformly accepted in different enterprises.

1. Convention of full disclosure

All significant information be disclosed, proforma prescribed by Companies Act. This does not mean leaking out secrets. Following items shown as footnotes1.Contingent liabilities (likely to arise). 2.Market value of investments. 3.Any changes in the method of valuation of depreciation, provision for bad debts, valuation of stock.

2.Convention of consistency
Accounting principles should not change year to year to facilitate comparison. Example- methods for depreciation and stock etc should not change. However, if current times need that a principle be changed for better disclosure of financial statements, then with justification and clarity the principle be changed.

3. Convention of materiality
Exception to principle of full disclosure. Irrelevant or insignificant info be left out and be shown as footnote or merged with other items. Material info is the info that could influence the investors decision. Accountant has to use his judgement in determining which info is material depending on who reads it.

4. Convention of conservatism/prudence
All anticipated profits be ignored and losses be accounted for. Insurance policies are shown at their surrender value. Provision for doubtful debts is created. Closing stock is valued at C.P or M.P whichever is less. Provision of a law suit is made though the law suit could be decided in its favor. Strategy of playing safe.

Effect of over-prudence1. Profits are understated. 2. Assets are understated and liabilities are over stated. 3. Secret reserves are created.