accounting
Principles
(It is classified into two categories)
1. Accounting Concepts2. Accounting Conventions
Accounting
concepts
In Simple
1)
Business entity concept:
while recording the business transactions, only those transactions which
have a bearing on the profit/loss of the firm (Concern) should be taken into
account from the view point of business.
2)
Money measurement concept:
Accounting records
only transactions that are expressed in terms of money. From the business point
of view services of employees and
depreciation on fixed assets like furniture, machinery should be measured in terms of money only but not in
any other terms.
3)
Cost concept:
Generally the
business transactions are recorded at cost in the books of accounts.
Eg:
A firm purchases a machine for Rs 100000 only
though
The machine Plays very important role in
the
Production activity.
4)
Going concern concept:
Accounts are recorded assuming that the business will continue for a
long time. While selling goods to outsiders or purchasing goods from outsider’s
business concern presumes that they will stay in the business for longer
period. In absence of this view there is no need to maintain books of account.
The concept is also useful to determine the value of fixed assets.
Eg: While taking a
properly on lease basis “the going concern
Concept
is Useful to assess the intangible assets like
Goodwill.
5)
Realization concept:
According to this
concept” imaginary profits” should not be recorded at all
6)
Dual Aspect concept:
As per this concept,
every transaction should have two aspects, one is “receiving aspect” and the
other is “giving aspect”. The “receiving aspect” is called “debit” and the
“giving aspect” is called “credit”. Therefore, for every debit, there is an
equal corresponding credit.
Eg: If
a machine is purchased for 50,000
Increase in the machine account
Increase in the cash
account both are Equal
OBJECTIVES
After studying this lesson, you will be able to :
Ø Explain the term accounting concept;
Ø Explain the meaning and significance of various accounting concepts
Business Entity, Money Measurement, Going Concern, Accounting Period,
Cost Concept, Duality Aspect concept, Realization Concept, Accrual Concept and
Matching Concept.
MEANING AND BUSINESS ENTITY CONCEPT
Let us take an example.
In India there is a basic rule to be followed by everyone that one should walk
or drive on his/her left hand side of the road. It helps in the smooth flow of
traffic. Similarly, there are certain rules that an accountant should follow
while recording business transactions and preparing accounts. These may be
termed as accounting concept. Thus, this can be said that:
Accounting concept refers to the basic assumptions and rules and principles
which work as the basis of recording of business transactions and preparing
accounts.
The main objective is to maintain uniformity and consistency in
accounting records. These concepts constitute the very basis of accounting. All
the concepts have been developed over the years from experience and thus they are
universally accepted rules. Following are the various accounting concepts that
have been discussed in the following sections:
Ø Business entity concept
Ø Money measurement concept
Ø Going concern concept
Ø Accounting period concept
Ø Accounting cost concept
Ø Duality aspect concept
Ø Realization concept
Ø Accrual concept
Ø Matching concept
Business entity concept
This concept assumes that, for accounting purposes, the business
enterprise and its owners are two separate independent entities. Thus, the
business and personal transactions of its owner are separate. For example, when
the owner invests money in the business, it is recorded as liability of the business
to the owner. Similarly, when the owner takes away from the business cash/goods
for his/her personal use, it is not treated as business expense. Thus, the
accounting records are made in the books of accounts from the point of view of
the business unit and not the person owning the business. This concept is the
very basis of accounting.
Let us take an example. Suppose Mr. Sahoo started business investing Rs100000.
He purchased goods for Rs40000, Furniture for Rs20000 and plant and machinery
of Rs30000. Rs10000 remains in hand. These are the assets of the business and
not of the owner. According to the business entity concept Rs100000 will be
treated by business as capital i.e. a liability of business towards the owner
of the business.
Now suppose, he takes away Rs5000 cash or goods worth Rs5000 for his domestic
purposes. This withdrawal of cash/goods by the owner from the business is his
private expense and not an expense of the business. It is termed as Drawings.
Thus, the business entity concept states that business and the owner are two
separate/distinct persons. Accordingly, any expenses incurred by owner for
himself or his family from business will be considered as expenses and it will
be shown as drawings.
Significance
The following points highlight the significance of business entity concept:
Ø This concept helps in ascertaining the profit of the business as only
the business expenses and revenues are recorded and all the private and personal
expenses are ignored.
Ø This concept restraints accountants from recording of owner’s
private/personal transactions.
Ø It also facilitates the recording and reporting of business transactions
from the business point of view
Ø It is the very basis of accounting concepts, conventions and principles.
MONEY MEASUREMENT CONCEPT
This concept assumes that
all business transactions must be in terms of money, that is in the currency of
a country. In our country such transactions are in terms of rupees. Thus, as
per the money measurement concept, transactions which can be expressed in terms
of money are recorded in the books of accounts. For example, sale of goods
worth Rs.200000, purchase of raw materials Rs.100000, Rent Paid Rs.10000 etc.
are expressed in terms of money, and so they are recorded in the books of
accounts. But the transactions which cannot be expressed in monetary terms are
not recorded in the books of accounts. For example, sincerity, loyality,
honesty of employees are not recorded in books of accounts because these cannot
be measured in terms of money although they do affect the profits and losses of
the business concern.
Another aspect of this concept is that the records of the transactions
are to be kept not in the physical units but in the monetary unit. For example,
at the end of the year 2006, an organization may have a factory on a piece of
land measuring 10 acres, office building containing 50 rooms, 50 personal
computers, 50 office chairs and tables, 100 kg of raw materials etc. These are
expressed in different units. But for accounting purposes they are to be
recorded in money terms i.e. in rupees. In this case, the cost of factory land
may be say Rs.12 crore, office building of Rs.10 crore, computers Rs.10 lakhs,
office chairs and tables Rs.2 lakhs, raw material Rs.30 lakhs. Thus, the total
assets of the organisation are valued at Rs.22 crore and Rs.42 lakhs.
Therefore, the transactions which can be expressed in terms of money is
recorded in the accounts books, that too in terms of money and not in terms of
the quantity.
Significance
The following points highlight the significance of money measurement concept:
Ø This concept guides accountants what to record and what not to record.
Ø It helps in recording business transactions uniformly.
Ø If all the business transactions are expressed in monetary terms, it
will be easy to understand the accounts prepared by the business enterprise.
Ø It facilitates comparison of business performance of two different periods
of the same firm or of the two different firms for the same period.
GOING CONCERN CONCEPT
This concept states that a business firm will continue to carry on its
activities for an indefinite period of time. Simply stated, it means that every
business entity has continuity of life. Thus, it will not be dissolved in the
near future.
This is an important assumption of accounting, as it provides a basis
for showing the value of assets in the balance sheet; For example, a company purchases
a plant and machinery of Rs.100000 and its life span is 10 years. According to
this concept every year some amount will be shown as expenses and the balance
amount as an asset. Thus, if an amount is spent on an item which will be used
in business for many years, it will not be proper to charge the amount from the
revenues of the year in which the item is acquired. Only a part of the value is
shown as expense in the year of purchase and the remaining balance is shown as
an asset.
Significance
The following points highlight the significance of going concern concept:
Ø This concept facilitates preparation of financial statements.
Ø On the basis of this concept, depreciation is charged on the fixed
asset.
Ø It is of great help to the investors, because, it assures them that they
will continue to get income on their investments.
Ø In the absence of this concept, the cost of a fixed asset will be
treated as an expense in the year of its purchase.
Ø A business is judged for its capacity to earn profits in future.
ACCOUNTING PERIOD CONCEPT
All the transactions are recorded in the books of accounts on the
assumption that profits on these transactions are to be ascertained for a
specified period.
This is known as accounting period concept. Thus, this concept requires that
a balance sheet and profit and loss account should be prepared at regular intervals.
This is necessary for different purposes like, calculation of profit, ascertaining
financial position, tax computation etc.
Further, this concept assumes that, indefinite life of business is
divided into parts. These parts are known as Accounting Period. It may be of
one year, six months, three months, one month, etc. But usually one year is
taken as one accounting period which may be a calendar year or a financial
year.
Year that begins from 1st of January and ends on 31st of December, is
known as Calendar Year. The year that begins from 1st of April and ends on 31st
of March of the following year, is known as financial year.
As per accounting period concept, all the transactions are recorded in
the books of accounts for a specified period of time. Hence, goods purchased and
sold during the period, rent, salaries etc. paid for the period are accounted
for and against that period only.
Significance
Ø It helps in predicting the future prospects of the business.
Ø It helps in calculating tax on business income calculated for a
particular time period.
Ø It also helps banks, financial institutions, creditors, etc to assess
and analyze the performance of business for a particular period.
Ø It also helps the business firms to distribute their income at regular intervals
as dividends.
ACCOUNTING COST CONCEPT
Accounting cost concept states that all assets are recorded in the books
of accounts at their purchase price, which includes cost of acquisition, transportation
and installation and not at its market price. It means that fixed assets like
building, plant and machinery, furniture, etc are recorded in the books of
accounts at a price paid for them. For example, a machine was purchased by XYZ
Limited for Rs.500000, for manufacturing shoes. An amount of Rs.1,000 were
spent on transporting the machine to the factory site. In addition, Rs.2000
were spent on its installation. The total amount at which the machine will be
recorded in the books of accounts would be the sum of all these items i.e. Rs.503000.
This cost is also known as historical cost. Suppose the market price of the
same is now Rs 90000 it will not be shown at this value. Further, it may be
clarified that cost means original or acquisition cost only for new assets and
for the used ones, cost means original cost less depreciation. The cost concept
is also known as historical cost concept. The effect of cost concept is that if
the business entity does not pay anything for acquiring an asset this item
would not appear in the books of accounts. Thus, goodwill appears in the
accounts only if the entity has purchased this intangible asset for a price.
Significance
Ø This concept requires asset to be shown at the price it has been
acquired, which can be verified from the supporting documents.
Ø It helps in calculating depreciation on fixed assets.
Ø The effect of cost concept is that if the business entity does not pay anything
for an asset, this item will not be shown in the books of accounts.
DUAL ASPECT CONCEPT
Dual aspect is the foundation or
basic principle of accounting. It provides the very basis of recording business
transactions in the books of accounts. This concept assumes that every
transaction has a dual effect, i.e. it affects two accounts in their respective
opposite sides. Therefore, the transaction should be recorded at two places. It
means, both the aspects of the transaction must be recorded in the books of
accounts. For example, goods purchased for cash has two aspects which are (i)
Giving of cash
(ii) Receiving of goods. These two aspects are to be recorded.
Thus, the duality concept is commonly expressed in terms of fundamental accounting
equation :
Assets = Liabilities + Capital
The above accounting equation states that the assets of a business are
always equal to the claims of owner/owners and the outsiders. This claim is
also termed as capital or owner’s equity and that of outsiders, as liabilities
or creditors’ equity.
The knowledge of dual aspect helps in identifying the two aspects of a transaction
which helps in applying the rules of recording the transactions in books of
accounts. The implication of dual aspect concept is that every transaction has
an equal impact on assets and liabilities in such a way that total assets are
always equal to total liabilities.
Let us analyze some more business transactions in terms of their dual aspect:
1. Capital brought in by the owner of the business
The two aspects in this transaction are :
(i) Receipt of cash
(ii) Increase in Capital (owners equity)
2. Purchase of machinery by cheque
The two aspects in the transaction are
(i) Reduction in Bank Balance
(ii) Owning of Machinery
3. Goods sold for cash
The two aspects are
(i) Receipt of cash
(ii) Delivery of goods to the customer
4. Rent paid in cash to the landlord
The two aspects are
(i) Payment of cash
(ii) Rent (Expenses incurred).
Once the two aspects of a transaction are known, it becomes easy to
apply the rules of accounting and maintain the records in the books of accounts
properly.
The interpretation of the Dual aspect concept is that every transaction
has an equal effect on assets and liabilities in such a way that total assets
are always equal to total liabilities of the business.
Significance
Ø This concept helps accountant in detecting error.
Ø It encourages the accountant to post each entry in opposite sides of two
affected accounts.
REALISATION CONCEPT
This concept states that revenue from any business transaction should be
included in the accounting records only when it is realised. The term realisation
means creation of legal right to receive money. Selling goods is realisation,
receiving order is not.
In other words, it can be said that:
Revenue is said to have been realised when cash has been received or
right to receive cash on the sale of goods or services or both has been
created.
Let us study the following examples:
(i) N.P. Jeweller received an order to supply gold ornaments worth Rs.500000.
They supplied ornaments worth Rs.200000 up to the year ending 31st December
2005 and rest of the ornaments were supplied in January 2006.
(ii) Bansal sold goods for Rs.1,00,000 for cash in 2006 and the goods
have been delivered during the same year.
(iii) Akshay sold goods on credit for Rs.50,000 during the year ending
31st December 2005. The goods have been delivered in 2005 but the payment
was received in March 2006.
Now, let us analyse the above examples to ascertain the correct amount
of revenue realised for the year ending 31st December 2005.
(i) The revenue for the year 2005 for N.P. Jeweller is Rs.200000. Mere getting
an order is not considered as revenue until the goods have been delivered.
(ii) The revenue for Bansal for year 2005 is Rs.1,00,000 as the goods
have been delivered in the year 2005. Cash has also been received in the same
year.
(iii) Akshay’s revenue for the year 2005 is Rs.50,000, because the goods
have been delivered to the customer in the year 2005. Revenue became due in the
year 2005 itself. In the above examples, revenue is realized when the goods are
delivered to the customers.
The concept of realisation states that revenue is realized at the time when
goods or services are actually delivered.
In short, the realisation occurs when the goods and services have been
sold either for cash or on credit. It also refers to inflow of assets in the
form of receivables.
Significance
Ø It helps in making the accounting information more objective.
Ø It provides that the transactions should be recorded only when goods are
delivered to the buyer.
ACCRUAL CONCEPT
The meaning of accrual is something that becomes due especially an
amount of money that is yet to be paid or received at the end of the accounting
period. It means that revenues are recognised when they become receivable. Though
cash is received or not received and the expenses are recognized when they
become payable though cash is paid or not paid. Both transactions will be
recorded in the accounting period to which they relate. Therefore, the accrual
concept makes a distinction between the accrual receipt of cash and the right to
receive cash as regards revenue and actual payment of cash and obligation to
pay cash as regards expenses.
The accrual concept under accounting assumes that revenue is realised at
the time of sale of goods or services irrespective of the fact when the cash is
received. For example, a firm sells goods for Rs 55000 on 25th March 2005 and
the payment is not received until 10th April 2005, the amount is due and
payable to the firm on the date of sale i.e. 25th March 2005. It must be
included in the revenue for the year ending 31st March 2005. Similarly,
expenses are recognised at the time services provided, irrespective of the fact
when actual payments for these services are made. For example, if the firm
received goods costing Rs.20000 on 29th March 2005 but the payment is made on
2nd April 2005 the accrual concept requires that expenses must be recorded for
the year ending 31st March 2005 although no payment has been made until 31st
March 2005 though the service has been received and the person to whom the payment
should have been made is shown as creditor.
In brief, accrual concept requires that revenue is recognised when realized
and expenses are recognised when they become due and payable without regard to
the time of cash receipt or cash payment.
Significance
Ø It helps in knowing actual expenses and actual income during a particular
time period.
Ø It helps in calculating the net profit of the business.
MATCHING CONCEPT
The matching concept states that the revenue and the expenses incurred
to earn the revenues must belong to the same accounting period. So once the revenue
is realised, the next step is to allocate it to the relevant accounting period.
This can be done with the help of accrual concept.
Let us study the following transactions of a business during the month
of December, 2006
(i) Sale: cash Rs.2000 and credit Rs.1000
(ii) Salaries Paid Rs.350
(iii) Commission Paid Rs.150
(iv) Interest Received Rs.50
(v) Rent received Rs.140, out of which Rs.40 received for the year 2007
(vi) Carriage paid Rs.20
(vii) Postage Rs.30
(viii) Rent paid Rs.200, out of which Rs.50 belong to the year 2005
(ix) Goods purchased in the year for cash Rs.1500 and on credit Rs.500
(x) Depreciation on machine Rs.200
Let us record the above transactions under the heading of Expenses and Revenue.
Expenses
Amount
Revenue Amount
Rs
Rs
1. Salaries 350 1. Sales
2. Commission 150 Cash 2000
3. Carriage 20 Credit 1000 3000
4. Postage 30 2.Interest
received 50
5. Rent paid 200
3. Rent received 140
Less for 2005 (50)
150 Less for 2007 (40) 100
6. Goods purchased
Cash 1500
Credit 500 2000
7. Depreciation on machine 200
Total 2900 Total 3150
In the above example expenses have been matched with revenue i.e (Revenue
Rs.3150-Expenses Rs.2900) This comparison has resulted in profit of Rs.250. If
the revenue is more than the expenses, it is called profit. If the expenses are
more than revenue it is called loss. This is what exactly has been done by
applying the matching concept.
Therefore, the matching concept implies that all revenues earned during
an accounting year, whether received/not received during that year and all cost
incurred, whether paid/not paid during the year should be taken into account while
ascertaining profit or loss for that year.
Significance
Ø It guides how the expenses should be matched with revenue for determining
exact profit or loss for a particular period.
Ø It is very helpful for the investors/shareholders to know the exact amount
of profit or loss of the business.
Accounting Conventions
1)
Consistency
2)
Conservation
3)
Disclosure
4)
Relevance
5)
Feasibility
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