Accounting Concepts and Principles

 Accounting concepts and conventions 

Accounting principles: concepts and conventions

Accounting principles = concepts + accounting conventions commonly known as GAAP (Generally accepted accounting principles) based on which financial statements are to be prepared. Accounting principles are divided into two parts, concepts, and conventions.

(A).  Accounting concepts:

Accounting concept refers to the basic assumptions and rules and principles which work as the basis of recording of business transactions and preparing accounts.

1) Going concern concept:

According to this, it is assumed that business shall continue for a foreseeable period and there is no intention to close the business or scale down its operations. It is because of this concept that a distinction between capital & revenue expenditure.

2) Consistency assumptions- 

Accounting practices once selected and adopted should be applied consistently year after year. Change if the law or accounting standard requires, straight-line method and written down value method.

3) Accrual concepts- 

A transaction is recorded in the books of accounts at the time when it is entered into and not when the settlement takes place. Thus revenue is recognized when it is realized. The concept is particularly important because it recognizes the assets, liabilities, income, and expenses as and when transactions relating to it are entered into.

4) Accounting entity or business entity- 

According to the business entity, principle business is considered to be separate and distinct from its owners. Business transactions, therefore, are recorded in the books of accounts from the business point of view and not from that of the owners. The accounting entity principle is useful as from its responsibility accounting has developed.

5) Money measurement principle- 

According to the money measurement principle, transactions and events that can be measured in money terms are recognized in the books of accounts of the enterprise. Money is the common denominator in recording & reporting all the transactions.

6) Accounting period principle:

According to the accounting period principle the life of an enterprise is broken into smaller periods so that its performance is measured at regular intervals. The life of the enterprise is broken into smaller periods which is termed as the accounting period. An accounting period is an interval of time at the end of which income statement (P & l account or statement of profit & loss in the case of companies and balance sheet are prepared to know the result and resources of the business.

7) Full disclosure principle – 

There should be complete and understandable reporting on the financial statement of all significant information relating to the economic affairs of the entity. Good accounting practice requires all material and significant information to be disclosed. The reason for low turnover should be disclosed.

8) Materiality concept – 

It refers to the relative importance of an item or an event. An item should be regarded as material if there is a reason to believe that knowledge of it would influence the decision of informed investors.

9) Prudence or conservatism principle- 

Do not anticipate a profit but provide for all possible losses. It takes into consideration all prospective losses but not the prospective profit. The financial statement presents a realistic picture of the state of affairs of the enterprise and does not paint a better picture than what it actually is conservatism does not record anticipated revenue but provide all anticipated expenses & losses. It may be used to create a secret reserve.

10) Cost concept or historical concept- 

According to this asset is recorded in the books of accounts at the price paid to acquire it and the cost is the basis for all subsequent accounting of the assets should be shown in the book of accounts at its book value. Cost concept brings objectivity in the preparation and presentation of financial statements. They are not influenced by personal bias or judgment.

11) Matching concept – 

It is necessary to match revenues of the period with the expenses of that period to determine the correct profit or loss for the accounting period. As per this concept, adjustments are made for all outstanding expenses, prepaid expenses, accrued income, unearned income. The expenses for an accounting period are matched against related revenues rather than cash received & cash paid.

12) Dual concept or duality- 

The transactions entered into by an enterprise have two aspects a debit and a credit of equal amount. For every debit, there is a credit of equal amount in one or more accounts. Capital = assets.

13) Revenue recognition concept- 

Revenue is considered to have been realized when a transactions has been entered into and the obligation to receive the amount has been established.

14) Verifiable objective concept- 

It holds that accounting should be free from personal bias. It means all accounting transactions should be evidenced and supported by business documents. These supporting documents are cash memos, invoices, sales bills, etc and they provide the basis for accounting & audit.

(B). Accounting conventions:

An accounting convention is a common practice used as a guideline when recording a business transaction. It is used when there is not a definitive guideline in the accounting standards that govern a specific situation. 

An accounting convention refers to a common practice that is universally followed in recording and presenting accounting information of the business entity. conventions denote customs or traditions or usages which are in use for long. To be clear, these are nothing but unwritten laws. The accounts have to adopt the usage or customs, which are as a guide in the preparation of accounting reports and statements. These conventions are also known as doctrine.

(1) convention of consistency: 

The conventions of consistency mean that the same accounting principles should be used for preparing financial statement year after year. A meaningful conclusion can be drawn from the financial statement of the same enterprise when there is a comparison between them over a period of time but this can be possible only when accounting policies and practices followed by the enterprise are uniforms, and consistent over a period of time. If different accounting procedures and practices are used for preparing financial statements for different years. Then the result will not be comparable.

(2) convention of full disclosure: 

Convention of full disclosure requires that all material and relevant facts concerning financial statements should be fully disclosed. Full disclosure means that there should be full, fair and adequate disclosure of accounting information. Adequate means a sufficient set of information to be disclosed. Fair indicates an equitable treatment of users. Full refers to a complete and detailed presentation of information. Thus, the convention of full disclosure suggests that every financial statement.

(3) conventions of materiality: 

The convention of materiality states that, to make financial statements meaningful, only material fact. Important and relevant information should be supplied to the users of accounting information. The question that arises here is what is a material fact. The material fact depends on its nature and the amount involved. The material fact means the information of which will influence the decision of its user.

(4) convention of conservatism: 

This convention is based on the principle that ‘’Anticipate no profit, but provide for all possible losses’’. It provides guidance for recording transactions in the books of accounts. It is based on the policy of playing safe in regard to showing profit.

The main objective of this convention is to show the minimum profit. Profit should not be overstated. If profit shows more than actual, it may lead to the distribution of dividends out of capital. This is not a fair policy and it will lead to a reduction in the capital of the enterprise.