Basic Accounting Concepts
Accounting is based on some Principles which are based on some assumptions which are called Accounting Concepts. These basic accounting concepts are widely accepted all over the world by professionals. These concepts / Principles are listed below.
b. Money measurement;
c. Going concern;
d. Accounting period;
f. Dual aspect;
g.Revenue recognition (Realization);
Accounting Conventions: Accounting convention frames the guideline that facilitates the preparation of accounting statements and reports. There are four Accounting conventions which are listed below.
c. Conservatism (Prudence);
a) Business Entity Concept: This concept assumes that business and its owner are two different persons or entities. This helps an accountant to identify the business transactions as only those should be recorded.
b) Money Measurement Concept: This accounting concept demands that only transactions which can be measured in monetary terms should be recorded in the books. Non-monetary transactions should not be recorded even if they are significant.
c) Going Concern Concept: This concept assumes that a business entity will exist indefinitely and will not close or shut in the near future. It has no intention to liquidate.
d) Accounting Period Concept: Accounting period is a definite period like one year, six months. Accounting statements are prepared at the end of this accounting period. Most of the entities in India follow an accounting period of one year starting from 1st April and ending on 31st March of next year. This accounting period is also called “Financial Year”.
e) Cost Concept: According to this concept, an asset should be recorded in the books at its original cost at which it was bought i.e. acquisition cost. It is also called a Historical Cost. Cost includes cost of acquisition plus all the expenditure incurred till making an asset in working condition.
f) Dual Aspect Concept: According to this concept, every transaction in the business will have two effects. That means minimum one debit and one credit, both of equal amount. This double aspect is the base of Accounting as the Double Entry System is based on Dual Aspect Principle. This aspect also gives us Accounting Equation
Assets = Liabilities + Capital
g) Revenue Recognition Concept: Revenue means cash inflow generated from sale of goods or services. This concept tells us that revenue generated by business should be included in accounting only when it is realized. Revenue is assumed to be realized when goods are sold or services are rendered. Therefore, in case of credit sales revenue is generated when sales are made irrespective of whether cash is received or not.
h) Matching Concept: These concepts emphasize that all the expenses incurred during the accounting period by the business entity, whether paid or not and all the revenues earned by the entity during the accounting period, whether received or not, should be considered or recorded so as to arrive real profit of that year. It may happen that sale happens in the last week of March but money is received in the 1st week of April, still sale will be considered for the accounting year ending on 31st March and not for the next accounting year starting on 1st April.
a) Full Disclosure: This convention entails the revelation of all relevant information, both favorable or unfavorable to the management of a business enterprise. For E.g. information required by tax authorities must be reported to them will be the full disclosure to Tax authorities. Full disclosure can be made in two ways:
- Either in the body of the financial statements, or
- In notes accompanying such financial statements
b) Consistency: According to the convention of consistency the company has to follow a method of accounting consistently. For E.g. Method of Depreciation or method of inventory valuation. Changing the accounting method often or every year would make the comparison of its own financial statements of different period difficult for the company. Moreover, the convention of consistency helps the management to analyze the financial statement of different periods and based on which future decisions can be taken, if needed. However, if a change is necessary for the accounting method then there must be a concrete reason for such change.
c) Conservatism: As per the Conservatism convention at the time of recording any financial transaction, you should recognize no profit but provide for all possible losses. This convention depends upon the theory that the future is uncertain. For instance, any legal case going on in the court and decision might impact on monetary loss or gain of the company.
d) Materiality: As per the accounting convention of materiality, an item is material if it can influence the decision of users of the financial statements. This convention is related to the significant importance of any event or item. Moreover, the materiality of an item depends on its amount and an events materiality depends upon its nature. Materiality convention enables the users to ignore all such transactions or items that are not relevant or material. For instance, for a small company Rs. 100 transaction is material whereas for big giants Rs. 100 is immaterial. Also rounding off to nearest rupee and ignoring paise is also matter of materiality.