what are concepts and conventions of accounting
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Re: what are concepts and conventions of accounting
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# 7 Accounting Concepts
The American Institute of Certified Public Accountants
defines accounting as “the art of recording, classifying and
summarising in a significant manner and in terms of money
transactions and events, which are, in part at least, of a
financial character, and interpreting the results thereof “.
A business house must necessarily keep a systematic record
of its day-to-day transactions to enable stakeholders to get
a complete financial picture of the company and to take
stock of its financial position on a periodic basis.
Stakeholders include the company’s promoters, shareholders,
creditors, employees, government and the public.
The accounting practice is based on certain standard
concepts, which enable accountants to convey meaningful
information to all stakeholders. These concepts are as
follows: -
· The business entity concept – According to this, the
business is treated as a distinct entity from its owners.
This enables the business to segregate the transactions of
the company from the private transactions of the proprietor
(s).
· The money measurement concept – Only those transactions,
which are expressed in monetary terms are recorded in the
books of accounting. Money is the common unit, which enables
various items of diverse nature to be summed up together and
dealt with.
· The cost concept – The transactions are recorded at the
amounts actually involved. For instance, a piece of land may
have been purchased at Rs.1,50,000, whereas the company
considers it to be worth Rs.3,00,000. The land is recorded
in the books of accounts at Rs.1,50,000 only. Thus, an
arbitrary valuation of the company’s assets is avoided by
recording the value at the actual amount involved. Since
this amount would have been mutually agreed upon by both the
parties involved in the transaction, it is an objective
valuation.
· The going concern concept – According to this concept, it
is assumed that the business will exist for a long time and
transactions are recorded on this basis. This concept forms
the basis for the distinction between expenditure that will
yield benefit over a long period of time and expenditure
whose benefit will be exhausted in the short-term.
· The dual aspect concept – Business firms raise funds in
any of the following ways–
o Additional capital (increase in owners’ equity)
o Earning revenue (increase in owners’ equity)
o Profits (increase in owners’ equity)
o Additional loans (increases outside liability)
o Disposing off assets (reduces assets)
An increase in liabilities (including owners’ equity) and
reduction in assets represent sources of funds. These funds
can be put to any of the following uses –
o Purchasing of assets (increase in assets)
o Cash balances (increase in assets)
o Operational expenses (decrease in owners’ equity)
o Clearing liabilities due (decrease in liabilities)
o Losses (decrease in owners’ equity)
All increases in assets and decreases in liabilities
(including owners’ equity) represent the uses of funds.
The sum of the sources of funds equals the sum of the uses
of funds. Thus, the dual aspect of accounting means that
Owner’s Equity + Outside Liability = Assets
This is the fundamental accounting equation.
· The realisation concept – Accounting records transactions
from the historical perspective, i.e. it records
transactions that have already occurred. It does not attempt
to forecast events; this prevents the business from
presenting inflated profits based on their expectations. A
transaction is recorded only on receipt of cash or a legal
obligation to pay. Until then, no income or profit can be
said to have arisen.
· The accounting period concept – Business firms prepare
their income statements for a particular period. This
period, known as the accounting period, is usually the
calendar year (January 1 to December 31) or the financial
year (April 1 to March 31). Some firms, like trading firms
have shorter periods such as a month or less, while others
may have longer terms. The Companies Act, 1956 has set a
maximum limit of 15 months for the accounting period.
· The matching concept – According to this concept, expenses
borne in the production of goods and services should be
matched with revenues realised from the sale of these goods
and services. This helps determine the profits or losses for
a particular accounting period.
· The conservatism concept – According to this concept,
revenues should be recognised only when they are realized,
while expenses should be recognized as soon as they are
reasonably possible. For instance, suppose a firm sells 100
units of a product on credit for Rs.10,000. Until the
payment is received, it will not be recorded in the
accounting books. However, if the firm receives information
that the customer has lost his assets and is likely to
default the payment, the possible loss is immediately
provided for in the firm’s books.
· The consistency concept – Once the firm adopts a
particular method for a particular event, it will handle
subsequent events of that type the same manner. For
instance, suppose it provides for depreciation through the
straight-line method, it will follow that method in the
subsequent years as well, unless it has sufficient reason to
change the method.
· The materiality concept – According to this concept, the
firm need not record events, which are insignificant and
immaterial. For instance, if a large manufacturing firm has
accounts receivables worth crores of rupees, it would not
find it necessary to provide for a possible bad debt worth
Rs.100.
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