ACCOUNTING CONCEPTS, PRINCIPLES & CONVENTIONS

Published On : 2018-10-17

1. Business Entity Concept

According to this assumption, for accounting purposes a business is treated as a separate entity that is distinct from its owners and all other economic proprietors. For example in case of a proprietary concern, though the legal entity of the business and its proprietor is not same for the purpose of accounting they are o be treated as separating from each other.


If this assumption is not followed, the financial status and operating results of a business entity cannot be ascertained.  In other words this assumption requires that for accounting purposes, a distinction should be made between 

(i) personal transaction and business transactions, and 

(ii) transactions of one business entity and transactions of another business entity.


2. Money Measurement Concept

As per this assumption only that transaction is capable of being expressed in terms of money is included in the accounting records.  Example if a sale director is not in speaking terms with the production director, the enterprise is bound to suffer. As monetary measurement of this information is not possible so this fact will not be recorded in accounting records. Also by expressing all transactions in terms of money different transactions expressed in different units are brought to a common unit of measurement that is money. 


3. Accounting period assumption.
This assumption is also known as periodicity assumption or time period assumption. According to this assumption the economic life of an enterprise is artificially split into periodic intervals which are known as accounting periods at the end of which an income statement and position statement are prepared to show the performance and financial position. The use of this assumption further requires the allocation of expenses between capital and revenue.

That part of capital expenditure which is consumed during the current accounting period is charged as an expense to income and the unconsumed part is shown in the balance sheet as an asset. Measuring the income following the concept of accounting period is like an estimate than fact as actual income can be determined only on the liquidation of business.


4. Going Concern Assumption
Going Concern Assumption is also known as continuity assumption. As per this assumption, the enterprise is normally viewed as a going concern, that is continuing of operation for the foreseeable future. It is assumed that the enterprise has neither the income following the concept of accounting period is more an estimate than factual since actual income can be determined only on the liquidation of the enterprise.

(i) Assets are classified as current assets and fixed assets.
(ii) Liabilities are classified as short-term liabilities and long–term liabilities
(iii) That unused recourses are shown as unutilized costs as against the break-up values as in case of liquidation of business. Accordingly, the earning power and not the bread-up value evaluate the continuing enterprise.

5. Revenue Recognition 
As per this principle revenue  is recognized when the other party becomes legally liable to pay the amount. Revenue Recognition concept implies that sale will not be considered at the time when the order is received but it will only be considered when the delivery of goods is made and the other party is legally liable to pay amount. 

6. Cost Concept
As per to Cost Concept, an asset is recorded at the price paid to acquire the asset it at the time of its acquisition and the cost becomes the basis of the accounts during the period of acquisition and subsequent accounting periods also.

In case nothing is paid to acquire an asset the same will not be recorded as an asset, for example a favorable location and increasing reputation of the concern will remain unrecorded though these are valuable assets. 


7.  Matching principle
Income made by the business during a period can be ascertained only when the revenue earned during a period is compared with the expenditure incurred for earning that revenue.

According to this principle the expenses incurred in an accounting period should be matched with the revenues recognized in that period e.g. if revenue is recognised on all goods sold during a period cost of those goods sold should also be charged to that period. 

So adjustments should be made for all outstanding expenses, accrued incomes, unexpired expenses and unearned incomes etc. while preparing the final accounts at the end of the accounting period.

This concept is based on accrual concept since it disregards the timing and the amount of actual cash inflow or cash outflow and relates expense to the revenue or the time when benefit is derived from expenses.

8. Objectivity Principle
According to this principle the accounting data should be definite, variable and free from the personal bias of the measures. In other words, this principle requires that each recorded transaction/event in the books of accounts should have adequate evidence to support it.

In historical cost accounting the accounting data are verifiable, since the transactions are recorded on the basis of source documents such as voucher receipts, cash memos, invoices, etc. At the same time the accounting data are neither subject to the bias of either management or the accountants whose prepares the accounts.  

9. Accrual Concept.
Revenues and costs are accrued i.e. recognized as they are earned or incurred and not as money is received or paid and recorded in the financial statements of the periods to which they relate. This assumption is the core of accrual accounting system. 

10. Dual Aspect Concept
As per this concept every transaction has two effects 
Effect of Giving
Effect of Receiving 
Accounting records both these aspects one denoting Debit and other Credit following the rules of debit and credit. 

As for every transaction both Debit and credit are recorded hence Debit is always equal to credit. It is due to this reason 

Assets = Liability + Capital

 ACCOUNTING CONVENTIONS

1. CONSERVATISM:
Accounting discourages accountants and managers to be too much optimistic and tries to make business funds available to survive any setback or loss in the business.

Due to this reason,  accountants follows the rule ‘TO ANTICIPATE NO PROFIT BUT PROVIDE FOR ALL POSSIBLE LOSSES’ while recording business transactions.  

In simple words, the accountant follows the policy of playing safe”. On account of this convention, the inventory is valued ‘at Cost or Market price whichever is less’. 

In the same manner a provision is made doubtful debts out of current year’s profits.

The convention of conservatism has become target of serious criticism these days especially on the ground that it goes against the convention of full disclosure. It encourages the account to create secrete reserves (e.g. by creating excess provision for bad and doubtful debts, depreciation etc.), and the financial statements do not depict a true and fair view of state of affairs of the business. The Income Statement shows a lower net income, the Balance Sheet understates assets and overstates liabilities.

2. FULL DISCLOSURE:
According to this convention accounting reports should disclose fully and fair  information about the business. They should be honestly prepared, and sufficiently disclose information which is of material interest to proprietors, present’ and potential creditors and investors for making their decisions. 

The convention is more important in modern times because most of big businesses are run by joint stock companies where ownership is divorced from management. The Companies Act, 2013, not only requires that Income Statement and Balance Sheet of a company must give a true and fair view of the state of affairs of the company but it also gives the prescribed forms in which these statements are to be prepared. 

Appending of notes to the accounting statements such as about contingent liabilities or market value of investments is in pursuant to the convention of full disclosure.

3. CONSISTENCY:
As per this convention the accounting practices should remain unchanged from one period to another. 

For example, if assets are valued at lower of cost or market value, it should be followed year after year. Similarly if depreciation is charged on fixed assets according to one method only year after year. 

This is important for the purpose of comparison. 

It does not completely restricts introduction of improved accounting techniques. So if it becomes necessary to adopt new technique (due to change in law or accounting policy) results in increase or decrease of profit as compared to the previous period, a note to that effect should be given in the financial statements.

4. MATERIALITY:
Accordingly to this convention the accountant should attach importance to material details and ignore insignificant details. This is because otherwise accounting will be unnecessarily overburdened with minute details.  

For example, while sending each debtor “a statement of ills account, complete details up to paise have to be given.  However, when a statement of outstanding debtors is prepared for sending to top management, figures may be rounded to the nearest ten or hundred. The Companies Act also permits ignoring of ‘paise’ while preparing financial statements. Similarly for tax purposes, the income has to be rounded to nearest ten. Thus, the term ‘materiality’ is a subjective term. The accountant should regard an item as material if there is reason to believe that knowledge of it would influence the 


CHARACTERISTICS OF GOOD ACCOUNTING INFORMATION

(a) Relevance: A principle is relevant to the extent it results information that is meaningful and useful to the user of accounting information.
(b) Objectively: Objectivity connotes reliability and trust worthiness. A principle is objective to the extent that the verifiability which means that there is some way of ascertaining the correctness of the information reported.
(c) Feasibility:  A principle is feasible to the extent that it can be implemented without much complexity or cost.
(d) Verifiability: Verifiability ensures the truthfulness of the recorded transactions, which can be checked by persons other than the accountant himself.
(e) Timeliness: The more quickly the information is communicated or provided to the users, the more likely it is to influence their decisions. Hence, accounting information should be made available at appropriate time without delays for prompt decision-making


QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS
Qualitative characteristics are attributes that make the information provided in financial statements useful to the users. The four principal qualitative characteristic of financial statements are understandability, relevance reliability and comparability as follows:

(a) Understandability An essential quality of the information provided in the financial statements is that is readily understandable by the users. But this does not means that information which is relatively complex and not easily understandable should not be included if it has a relevance in relation to decision making by the users. In fact a balancing is to be made between understandability and relevance. What is relevant for the users may not be provided in general purpose financial statement. Usually the law governing the financial reporting system, for example, the Companies act in case of companies, suggests general purpose format for financial. Later on the students will find the schedule VI to the companies Act, gives such a format.

(b) Relevance: The relevance of information is affected by its nature and materiality information becomes material financial statements. Materiality depends on the size of the item or error judged in the particular circumstances of its omission or mis-statement. Thus materiality provides a threshold or cut off point rather than being a primary qualitative characteristic which information must have, if it is to be useful.

(c) Reliability: If information is relevant, it could not serve users, purpose unless it is reliable.

(d) Comparability: The financial statement information should have the characteristic of comparability. Usually the users want to compare information across the firms, i.e. data of one business fir are compared with that of the others. By this way the users want to develop some judgment.  But accounting as social science is not guided by exact principles and law, Wide variation of principles and policies between business firms make comparison difficult. To curtail the widely varying accounting principles and policies between business firms make comparison difficult. To curtail the widely varying accounting principles and policies, professional accounting bodies throughout the world have recommended statements and standards, some of which are mandatory and the others are re commendatory in nature.

The other qualitative characteristics of financial statements are faithful representation, substance over form, prudence and competence. To become reliable there should be faithful representation o transactions and evens as they occur. By dual aspect concept even if some suppression is there still the balance sheet will tally only by faithful representation accounts can be meaningful.

LIMITATIONS OF FINANCIAL STATEMENTS
Financial statements are of immense value for assessing the performance and financial position of a business undertaking or any other institution requiring use of scarce resources However, one should remember also that statements suffer from a number of limitations. On must, therefore, keep in mind these limitations while studying the profit and loss account and the balance sheet of a company. 

The limitations may be categorized as follows:
(a) Limitations because if the financial statements are prepared mainly for shareholder whereas these are of interest to a number of other parties also.
(b) Limitations born out of the fact that the financial statements can be drawn up on the basis of varying accounting policies and practices.
(c) Limitations arising from the use of money as the money as the measuring unit.
(d) Limitations because of the fact that the financial statements by their very nature cannot include information on some vital qualitative factors and vital assets such as human resources.

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