Accounting Principles and Concepts
The theory base of accounting includes principles, concepts, rules and guidelines developed which are necessary to make the accounting information meaningful and reliable so that users can make decisions.
The Institute of Chartered Accountants of India, (ICAI), which is the regulatory body for standardization of accounting policies in India, has issued Accounting Standards which are expected to be uniformly adhered to, in order to bring consistency in the accounting practices. These are:
Generally Accepted Accounting Principles (GAAP)
Generally Accepted Accounting Principles refer to the rules or guidelines adopted for recording and reporting of business transactions in order to bring uniformity in the preparation and presentation of financial statements.
These principles are also referred to as concepts, conventions, principles, postulates, conventions, modifying principles, assumptions, etc. used interchangeably and referred to as basic accounting concepts.
Basic Accounting Concepts  Â
The basic accounting concepts are referred to as the fundamental ideas or basic assumptions underlying the theory and practice of financial accounting and are broad working rules of accounting activities.
- Business entity concept.
- Money measurement concept.
- Going concern concept.
- Accounting period concept.
- Cost concept.
- Dual aspect (or Duality) concept.
- Revenue recognition (Realisation) concept.
- Matching concept.
- Full disclosure concept.
- Consistency concept.
- Conservatism (Prudence) concept.
- Materiality concept.
- Objectivity.
Business Entity concept
This concept assumes that business has distinct and separate entity from its owners. For the purpose of accounting, business and its owners are to be treated as two separate entities.
Business assets and personal assets of the proprietor and business liabilities and personal liabilities of the proprietor are to be kept separate. Only business transactions should be recorded in accounting books.
Any personal transaction is to be ignored.
Money Measurement concept
The concept of money measurement states that only those transactions and happenings in an organisation, which can be expressed in terms of money are to be recorded in the book of accounts.
Also, the records of the transactions are to be kept not in the physical units but in the monetary units. Any transaction not expressed in terms of money should not be recorded e.g. Goods purchased can be recorded but loyalty of workers towards the business cannot be recorded.
Going Concern concept
The concept of going concern assumes that a business firm would continue to carry out its operations indefinitely (for a fairly long period of time) and would not come to an end in the near future.
So, difference must be made in fixed assets and current assets and capital items and revenue items.
Accounting Period concept
Accounting period refers to the period of time at the end of which the financial statements of an enterprise are prepared to know the amount of profits or losses during that period and to know its financial position i.e. position of its assets and liabilities, at the end of that period.
These financial statements are prepared in the form of Income statement and Position statement i.e. Statement of Profit and Loss and Balance Sheet.
Generally a period of twelve months is considered an accounting period which may be calendar year or Government’s financial year commencing with first day of April and ending with the last day of March next or any other such period.
Cost Concept
The cost concept requires that all assets are recorded in the books of accounts at their cost price, which includes cost of acquisition, transportation, installation and making the asset ready for the use e.g.an asset purchased for₹ 30,000 on which carriage ₹ 500 has been paid should be recorded at ₹ 30,500.
Dual Aspect Concept
Dual aspect or Duality concept states that every transaction has a dual or twofold effect on various accounts and should therefore be recorded at two places e.g. when goods are purchased for cash, goods are increasing stock and cash is decreasing, both of which must be recorded and should be same in books.
The duality principle is commonly expressed in terms of fundamental accounting equation, which is:
Capital + Liabilities = Assets
Balance sheet is based on this equation.
Revenue Recognition
Revenue is the gross receipts of cash arising from the sale of goods and services by an enterprise and interest, royalties and dividends etc.
According to this concept of revenue recognition, the revenue for a business transaction should be considered realized when legal right to receive it arises e.g. When goods are sold, revenue should be recorded though the cash is received after a few days, or a bill of exchange is received that will mature after two months.
Matching concept
According to the matching concept expenses incurred in an accounting period should be matched with revenues during that period, in order to calculate the results of business operations in terms of Profit or Loss.
Excess of Revenues over Expenses represent Profit and vice-versa. It follows from this that the revenue and expenses incurred to earn this revenue must belong to the same accounting period.
Full Disclosure concept
This concept requires that all material and relevant facts concerning financial performance of an enterprise that can affect the decision making by the users of accounting information must be fully and completely disclosed in the financial statements.
If there is need, some information can be given in the form of footnotes.
Consistency concept
This concept states that accounting policies and practices followed by enterprises should be uniform and consistent over the period of time so that results are comparable.
Results are comparable when the same accounting principles are consistently being applied by different enterprises for the period under comparison, or the same firm for a number of periods. If however, there is a change in the methods or policies, it must be mentioned.
Conservatism concept
This concept requires the business to play safe. It means that business transactions should be recorded in such a manner that profits are not overstated.
All anticipated losses should be accounted for but all unrealized gains should be ignored. It means that profits are to be recorded only when actually become due, but provisions for any possible losses must be made.
Materiality concept
This concept states that accounting should focus on material facts means important from effect on decision making point of view.
If the item is likely to influence the decision of a reasonably prudent investor or creditor, it should be regarded as material, and shown in the financial statements i.e. Income Statement as well as Balance Sheet.
Objective Evidence concept
According to this concept, accounting transactions should be recorded in the manner so that it is free from the bias of accountants and others. It should not be affected by the prejudices of the persons using this information.
Try Once more
Systems of Accounting
There are two systems of recording business transactions, double entry system and single entry system. Under double entry system every transaction has two-fold effects where as single entry system is known as incomplete records.
Basis of Accounting
The two broad approach of accounting are cash basis and accrual basis. Under Cash basis transactions are recorded only when cash are received or paid. Whereas under Accrual basis, revenues or costs are recognized when they occur rather than when they are paid.
Accounting Standards
Accounting standards are written statements of uniform accounting rules and guidelines in practice for preparing the uniform and consistent financial statements. These standards cannot over ride the provisions of applicable laws, customs, usages and business environment in the country.
Accounting Standards (AS)
The ICAI has issued the following standards:
AS 1 Disclosure of Accounting Policies
AS 2 Valuation of Inventories
AS 3 Cash Flow Statements
AS 4 Contingencies and Events Occurring after the Balance Sheet Date
AS 5 Net Profit or Loss for the Period, Prior Period items and Changes in Accounting Policies
AS 6 Depreciation Accounting
AS 7 Construction Contracts
AS 8 Accounting for Research and Development
AS 9 Revenue Recognition
AS 10 Accounting for Fixed Assets
AS 11 The Effects of Changes in Foreign Exchange Rates
AS 12 Accounting for Government Grants
AS 13 Accounting for Investments
AS 14 Accounting for Amalgamations
AS 15 Accounting for Retirement Benefits in the Financial Statements of Employers (recently revised and titled as ‘Employee Benefits’)
AS 16 Borrowing Costs
AS 17 Segment Reporting
AS 18 Related Party Disclosures
AS 19 Leases
AS 20 Earnings Per Share
AS 21 Consolidated Financial Statements
AS 22 Accounting for Taxes on Income
AS 23 Accounting for Investments in associates in Consolidated Financial Statements
AS 24 Discontinuing Operations
AS 25 Interim Financial Reporting
AS 26 Intangible Assets
AS 27 Financial Reporting of Interests in Joint Ventures
AS 28 Impairment of Assets
AS 29 Provisions, Contingent Liabilities and Contingent Assets